WASHINGTON — The U.S. economic slump took center stage Wednesday as new data revealed an economy teetering on recession, the Federal Reserve shaved another half-point off interest rates and the Senate began working on a stimulus plan of its own to jolt consumer and business spending.
The Federal Reserve reduced its benchmark federal funds rate — the overnight rate that banks charge each other — to 3 percent on Wednesday afternoon. In just eight days, the central bank chopped its benchmark rate by 1.25 percentage points, underscoring its concerns that the U.S. economy is going into a near stall.
This view was underscored by Commerce Department data released hours before the rate cut, which showed that the U.S. economy grew by a sub-par 2.2 percent in 2007 and a tepid 0.6 percent in the last quarter of the year.
That number was roughly half the growth rate that most mainstream economists had anticipated. It confirmed that the U.S. economy had little tailwind behind it going into what's been a volatile start to 2008.
"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said its statement. "Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets."
The statement left open the possibility of more rate reductions in the months ahead.
"Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain," it said.
Commercial banks mirrored the Fed's move, lowering their prime rate — which they charge their best borrowers — to 6 percent. The Fed also made a half-point cut to the rate it charges banks for emergency borrowing.
Stocks rallied after the announcement, but by the close of trading the Dow Jones Industrial Average finished down 37.47 points to 12,442.83, while the S&P 500 was off 6.49 points to 1,355.81. The tech-heavy Nasdaq closed down 9.06 points to 2,349.00.
When the Fed began lowering rates last September, its benchmark rate was 5.25 percent and the prime rate was 8.25 percent.
Usually, lower rates make it cheaper to take out a car loan, pay off credit card debt or buy inventory for a small business. But turbulent credit markets and a deep slump in the housing sector may mute some of the benefits of all the rate reductions, whose effects in any case won't felt across the broader economy for months. Banks and other lenders have become reluctant to lend to anyone but borrowers with strong credit histories.
Commerce Department economic-growth data released Wednesday underscored how much housing is hurting the broader economy. Investment in residential housing fell by the largest quarterly amount since 1981, and that's dampening the Fed's efforts to jump-start the economy.
"The principal link between monetary policy and the economy is the housing market, and this link is being short-circuited by the housing recession," said Mark Zandi, the chief economist for Moody's Economy.com, a forecaster in West Chester, Pa.
Speaking in Washington to a real estate group Wednesday, Treasury Secretary Henry Paulson warned that a housing rebound appears unlikely anytime soon.
"While a swift, simple and substantive fiscal-growth package will provide a boost and add to job creation this year, it is not intended or expected to slow down the housing correction. After years of unsustainable home-price appreciation, this is a necessary correction," he said.
President Bush and Congress are rushing to put together an economic stimulus plan, hoping that the combination of tax rebates for consumers and tax breaks for businesses will spur consumer spending, which drives two-thirds of U.S. economic activity.
The $150 billion stimulus measure passed the House of Representatives on Tuesday, but the Senate began modifying the plan Wednesday, risking conflict with the House and a potential presidential veto.
Bush used a visit to a helicopter-manufacturing plant in Torrance, Calif., to warn senators that "if you're truly interested in dealing with the slowdown in the economy, the Senate ought to accept the House package, pass it and get it to my desk as soon as possible."
Wednesday's economic data underscored why quick passage of a stimulus plan in Washington is vital. The new data confirm that consumer spending is slowing and that consumers have less money left over after meeting their basic needs.
Consumer spending rose by 2 percent in the fourth quarter, down from 2.8 percent in the third quarter. That level contributed 1.37 percentage points to economic growth in the fourth quarter, down from 2.01 percentage points in the third quarter. Real disposable personal income grew by just 0.3 percent, well off the 4.5 percent increase during the previous quarter.
The troubled housing sector negated almost all gains from consumer spending. Investment in residential housing fell 24 percent from October through December, shaving an estimated 1.18 percentage points off the economic growth rate.
In previous quarters, growing U.S. exports had offset the negatives from housing. But in the fourth quarter, exports contributed less than half a percentage point to the economic growth rate.
The biggest surprise in Wednesday's data was that business inventories fell during the last three months of 2007, in the past a harbinger of recession. But inventory management has grown more precise in recent years and the drop in inventories could signal that companies already are well positioned to operate in a slower economy.
"The inventory drawdown was nearly all in vehicle inventories. The auto manufacturers won't be building (more of) them anytime soon," Zandi said. "Inventories elsewhere aren't over-laden but not lean either. Inventory changes are unlikely to play a role in determining overall growth during the first half of the year."
Whether the economy averts recession now depends on how businesses spend and hire. December's weak employment numbers led many economists to increase the odds for recession, and the eyes of Wall Street and Main Street now turn to the Labor Department's release of January employment data on Friday.
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Commerce Department growth data.
The Fed's statement.