Economists said that the trajectory of the recovery could hinge on the outcome of the rancorous debate over the amount the nation can borrow. And the data inflamed the partisan debate about the government’s role in stimulating the economy.
Liberals said the weak gross domestic product figures showed that massive government cutbacks were unwise, while conservatives said that lowering the budget deficit should be the priority.
President Obama seized on the report to urge lawmakers to reach a compromise on raising the federal borrowing limit.
“The power to solve this is in our hands,” Obama said at the White House. “And on a day when we’ve been reminded how fragile the economy already is, this is one burden we can lift ourselves.”
The bad economic news and the uncertainty over the debt ceiling helped drag stocks to another losing session Friday, leaving the markets with their worst week in a year.
The Dow Jones industrial average, an index of blue-chip stocks, fell 537.92 points this week, or 4.24 percent — its largest weekly drop since July 2010. [Story, Page 19] The Standard & Poor’s 500 index and tech-heavy Nasdaq were both down about 4 percent this week.
The second quarter’s gross domestic product growth rate, the broadest measure of economic activity, is far lower than the 1.8 percent rate many economists estimated.
Moreover, Commerce had said the economy grew at a 1.9 percent annual rate during the first quarter, but the agency revised that figure to 0.4 percent. Together, the data show that economic growth during the first half of 2011 was at its slowest pace since the recession ended.
The largest drag on economic growth during the second quarter was state and local governments, which are cutting jobs and billions of dollars in spending to balance their budgets. While federal spending increased, state and local spending dropped at a rate of 3.4 percent.
“The state fiscal gaps still look very wide over the next couple of years and will probably get worse in the coming year,” said Josh Bivens of the Economic Policy Institute.
States were able to delay cutbacks when they received hundreds of billions of dollars from the federal government in 2009 to ride out the recession, but that money has all been spent. Now state governments are slashing spending and raising taxes.
The pace of state and local spending has declined for seven of the last eight quarters and is not likely to improve soon, economists said. Instead, they said the specter of more government cutbacks, whether as part of a deal to raise the debt ceiling or as a consequence of congressional leaders failing to reach an agreement, is likely to trickle down to localities and could further hold back economic growth.
But there may be an upside to such cutbacks, said John Ryding, chief economist at RDQ Economics. “State and local governments are getting themselves into a healthier position. They may not necessarily be the drag [on economic growth] that they have been in the last year,” he said.
Meanwhile, however, the weak pace of the national economy’s expansion is far too sluggish to bring down unemployment and, if sustained, could drive an already elevated unemployment rate up, economists said.
“The economy essentially stalled in the first half of the year,” said Eric Stein, a portfolio manager at Eaton Vance, an investment manager.
The figures were released as Congress scrambles to approve legislation by Aug. 2 to restore the country’s finances — raising the federal borrowing limit and cutting the budget deficit over the next decade.
The debt ceiling debate may have already done some damage to the economy, economists said. “The D.C. standoff — at the least — will have sapped consumer willingness to spend, business willing to hire, business willingness to make big ticket purchases” in the near term, said Nigel Gault, chief economist at IHS Global Insight. “That is already done.”
Gault had been forecasting a return to a 3 percent growth rate in the third quarter. Now “that is not going to happen,” he said. “The third quarter won’t necessarily be worse than the second, but it will be a bad quarter.”
The new economic data also reinforced economists fears that the country was breaking from the traditional pattern of a recession being followed by a steep recovery. Instead, economic growth has been sluggish, and it is taking far longer than usual to regain the country’s previous economic output.
The U.S. economy needs to grow by 2.5 percent a year over the longer term to accommodate population increases and improvements in worker productivity. Even at that rate, the labor market would just be treading water and would be unable to put the millions of Americans still unemployed back to work.
Consumer spending, an important part of economic growth and the largest component of economic growth, was also disappointing during the quarter. Personal consumption growth stalled at a 0.1 percent annual rate, down from 2.1 percent during the previous quarter, as higher fuel prices prodded consumers to pull back, according to Commerce Department data.
“There is a very real concern that we are seeing a retrenchment in consumer spending,” said Bernard Baumohl, chief global economist at the Economic Outlook Group. “Even those people who are working are seeing their wages grow at a pace that can’t keep up with inflation.”
The drag on growth during the second quarter may have been temporary, some economists said. Spending on cars, for instance, may have been slowed by supply chain disruptions caused by Japan’s tsunami.
Business spending and exports were bright spots in the report. Private investment grew at a 7.1 percent rate, while exports expanded at a 6 percent rate.
But there were even weak spots within those numbers. One of the chief components of business spending, equipment and software, grew at a slower pace in the second quarter than earlier in the year.
“Business spending was up, but it wasn’t that robust,” said Ryding. “If you look really hard, there was very little by way of positive news.”