Growth in the U.S. economy slowed sharply to a 1.8 percent pace in the winter quarter from 3.1 percent at the end of last year as budget cuts at all levels of government and a surge in oil prices weighed on the economy, the Commerce Department reported Thursday.
The jump in oil prices to more than $100 a barrel, and soaring prices for corn, wheat and other commodities, caused a near doubling of the inflation rate to 3.8 percent from 2.1 percent in the fourth quarter of 2010. That meant that consumers had less spending power, causing their contribution to economic growth to decline to 2.7 percent from 4 percent.
“Sharply higher gasoline and food prices are taking a toll on growth,” said Sam Bullard, a senior economist at Wells Fargo Securities. He said that caused consumers to backpedal after they fueled robust spending growth at the end of last year.
“Retail gasoline prices have risen roughly 85 cents since the start of the year, while food prices were up an annualized 7.5 percent” during the quarter, he said. Still, “consumer spending held up reasonably well despite those challenges.”
While consumers and businesses got zapped by higher inflation, governments faced with unsupportable debts at every level slashed spending.
The collective drop of 5.2 percent in government spending was the largest since 1983, provoking a lively political debate about the role government spending plays in the economy.
Republicans such as Rep. Tom Price of Georgia, the House Republican Policy Committee chairman, continued to call for more spending cuts, insisting that they will help the economy by spurring faster growth in the private sector. But Democrats and liberal groups said the report shows that cutting spending too fast will throttle the economic recovery.
Federal Reserve Chairman Ben S. Bernanke tends to view government spending as a stimulus for the economy, but he and other economists also warn about the danger of too much spending and debt.
Christian Proano, assistant professor of economics at the Schwartz Economic Policy Center, said “it is undeniable” that governments need to pare down sovereign debts, which collectively total nearly 95 percent of economic output a level deemed dangerous in economic circles.
“However, an overly hasty reversal of the U.S. fiscal stance based primarily on government spending cuts could be counterproductive given the fragile situation of the U.S. economy,” he said.
Thursday’s report clearly showed that governments at all levels are increasingly constrained by mounting debt. The public sector overall emerged forcefully during the first quarter as a dead weight on growth after helping to support the economy during most of the Great Recession and early recovery period.
The federal government axed defense spending by 11.7 percent nearly six times the decrease seen at the end of 2010. State and local spending fell by 3.3 percent after dropping 2.6 percent in the fourth quarter.
Wells Fargo’s Mr. Bullard said the drag from government budget cuts was significant and should continue for some time “as officials are forced to continue to make difficult decisions in terms of spending cuts and tax increases to bring deficits under control.”
States and local governments have been in a retrenchment mode for more than a year. But while the drop in federal defense spending was eye-popping, analysts say overall that the federal government is not acting to reduce growth because generous tax cuts enacted in December are offsetting recent spending cuts.
“Overall federal fiscal policy is roughly neutral for growth, with the payroll tax cut and extended unemployment insurance benefits offsetting the drag from the winding down of stimulus spending,” said Augustine Faucher, an economist at Moody’s Analytics.
Mr. Bernanke also said at a news conference Wednesday that he is not worried that federal spending cuts are endangering growth, although he has openly fretted from time to time that state and local budget cuts will hurt the economy.
Mr. Bernanke emphasized that the huge federal debt, at $14 trillion and growing rapidly, is a far bigger threat to the economy in the long run, and it is important for Congress and the White House to reach a deal to curb the growth in federal spending, he said.
Like many economic forecasters, Moody’s and the Fed expect the economy to overcome high gasoline prices, spending cuts and other recent obstacles and resume a solid growth rate of more than 3 percent this year.
“The recovery is turning into a self-sustaining expansion, with stronger job growth driving consumer spending gains, in turn adding to the improvement in the labor market,” Mr. Faucher said. “By the end of this year the economy will be adding around 250,000 jobs per month.”
Economists were not overly concerned about a jump in state unemployment claims to 429,000 last week, noting that the job trends have been improving overall with the unemployment rate down to 8.8 percent from double-digit levels during the recession.
Mr. Bernanke stressed that the economic slowdown early this year was influenced by transitory factors, including harsh weather that held back construction, as well as the surge in oil prices.
But he conceded that the leap in regular gasoline prices to more than $3.80 a gallon, with prices exceeding $4 for various blends across the country, has been a hardship for consumers and is seriously impairing their spending power. He said he expects inflation to subside to about 2 percent in the months ahead.
While Mr. Bernanke sought to put a good face on the shifting economy, Bernard Baumohl, an economist at the Economic Outlook Group, said the first quarter developments were difficult for the central bank.
“There is no greater curse on Fed policymakers than the combination of a slowing economy and accelerating inflation, especially when both are largely the result of events taking place outside the U.S.,” he said.
“In this instance, it is robust demand for food and fuel coming from fast-growing emerging countries and the geopolitical turmoil that has spread across the oil-rich regions of North Africa and the Middle East. And neither of these foreign dynamics show signs of de-escalating.”
Mr. Bernanke said there is nothing the Fed can do to curb the rise in oil prices caused by the Middle East turmoil, other than throw the economy back into a recession by raising interest rates.