Economy quells fear of decline

First-period growth in GDP at 2%, double the expected pace

Hidden bad news

Some economists see end of recession threat, others unsure

April 28, 2001|By William Patalon III | William Patalon III,SUN STAFF

The U.S. economy grew at a faster-than-projected pace in the first three months of the year, though economists remain divided on the direction the economy will take.

The Commerce Department said yesterday that gross domestic product - the sum of all goods and services produced in the United States - expanded at a 2 percent pace in the first quarter. That was about twice the rate predicted by many economists and was far better than some forecasts calling for the start of a recession with no growth.

Even so, some economists said that the numbers masked continued weakness and that the risk of a recession was still very real. Indeed, the numbers could be revised downward.

"A 2 percent growth rate is not one which is consistent with a growth in corporate profits," said Thomas F. Carpenter, chief economist for ASB Capital Management, the money-management arm of Chevy Chase Bank. "In fact, that's consistent with weakening corporate profits, which is consistent with a continued reduction in corporate spending" - leading to the kind of cost-cutting that includes widespread job losses.

According to the most recent GDP reports, the economy had been heading downward, slumping from a 2.2 percent growth rate in last year's third quarter to 1.0 percent in the fourth quarter. That was the economy's slowest pace in 5 1/2 years and had spawned fears that a recession would take hold in the first three months of this year.

Instead, the GDP report hinted at a recession-dodging rebound, many economists said.

"Barring something really bizarre, I think we're going to escape it," said Joel Naroff, president of Naroff Economic Advisors in Holland, Pa.

The report also buoyed investors. The Dow Jones industrial average surged 117.70 points, or 1.1 percent, to close at 10,810.05 - the first time that index has been in the black year-to-date since March 8. The Nasdaq rose 40.82 points, or 2.01 percent, to finish at 2,075.70.

Consumer spending

Boosting overall growth was a 3.1 percent increase in consumer spending. That reflected a huge jump in spending on "durable goods" - big-ticket items such as cars, furniture and appliances - which soared at an annual rate of 11.9 percent during the first quarter, after shrinking 3.1 percent in last year's fourth quarter.

Consumer spending accounts for two-thirds of all activity in the U.S. economy and is key to how the economy will perform. When consumers kept their wallets in their pockets during the final three months of last year - leading to a weak Christmas shopping season - economists began to fear the country was heading into a downturn, if not an outright recession.

Optimism declining

Despite yesterday's upbeat reaction, optimism in the economy is on the wane. The University of Michigan's final index of consumer sentiment dropped to 88.4 in April from 91.5 in March. Since November, this closely watched index has fallen 19.2 points, the biggest drop since the one between July and October 1990, the start of the last recession the country has suffered.

Fueling this decline in consumer confidence has been a bear market in technology stocks, the one-time darlings of investors. In the technology sector, company after company has warned of lower profits, and several have announced major work-force reductions, chiefly because the customers of these companies have slashed their spending on capital goods.

Faced with a flood of bad corporate and economic news, the Federal Reserve has already cut short-term interest rates by half a percentage point four times this year and economists say further reductions are possible. Fed policy-makers next meet May 15.

"While the Fed will cautiously watch spending developments in the second quarter," the strong first-quarter growth could mean that subsequent reductions will be smaller, said Peter Kretzmer, an economist with Banc of America Securities in New York City.

Yesterday's GDP report doesn't figure to end the consternation and confusion about which course the economy will take.

A key positive was consumer spending growth, which contributed more than 2.0 percentage points to growth in this year's first quarter. Another contributor was a narrowed trade deficit - reflecting a drop-off in imports - which added 1.4 percentage points to overall growth, the first time in more than two years that trade actually buttressed the expansion.

Rebounds in housing construction and strong spending by governments also nudged growth higher.

Good news in inventories

One factor that dragged down the quarter's growth rate - but was a long-term positive - was the continuing effort by businesses to reduce their inventories of unsold goods, which subtracted 2.5 percentage points from the GDP growth rate.

Inventory gluts force firms to cut back on production, which can cost workers their jobs if the gluts linger.

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