Stronger-than-expected Q3 U.S. growth rate fueled by Americans who spent more by earning less, businesses that invested in machines, leaving some experts to doubt whether pace can be sustained

Cindy Allen

WASHINGTON , October 27, 2011 (Associated Press) – A summer of modest economic growth is helping dispel lingering fears that another recession might be near.

Whether the strength can be sustained is less certain.

The economy grew at an annual rate of 2.5 percent in the July-September quarter, the Commerce Department said Thursday. But the growth was fueled by Americans who spent more while earning less and by businesses that invested in machines and computers, not workers.

The expansion, the best quarterly growth in a year, came as a relief after anemic growth in the first half of the year, weeks of wild stock market shifts and the weakest consumer confidence since the height of the Great Recession.

The economy would have to grow at nearly double the third-quarter pace to make a dent in the unemployment rate, which has stayed near 9 percent since the recession officially ended more than two years ago.

For the more than 14 million Americans who are out of work and want a job, that's discouraging news. And for President Barack Obama and incumbent members of Congress, it means they'll be facing voters with unemployment near 9 percent.

"It is still a very weak economy out there," said David Wyss, former chief economist at Standard & Poor's.

For now, the report on U.S. gross domestic product, or GDP, sketched a more optimistic picture for an economy that only two months ago seemed at risk of another recession.

And it came on the same day that European leaders announced a deal in which banks would take 50 percent losses on Greek debt and raise new capital to protect against defaults on sovereign debt.

Stocks surged on the European deal and maintained their gains after the report on U.S. growth was released. The Dow Jones rose 340 points to close at 12,209. The Dow hadn't closed above 12,000 since Aug. 1. The Standard & Poor's 500 index is close to having its best month since 1974.

If higher stock prices lead consumers to feel more confident about their wealth, they may spend more. That could help sustain economic growth.

The GDP report measures the country's total output of goods and services. It covers everything from bicycles to battleships, as well as services such as haircuts and doctor's visits.

Some economists doubt the economy can maintain its modest third-quarter pace.

U.S. lawmakers are debating deep cuts in federal spending next year that would drag on growth. And state and local governments have been slashing budgets for more than a year.

Obama's $447 billion jobs plan was blocked by Republicans, meaning that a Social Security tax cut that put an extra $1,000 to $2,000 this year in most American's pockets could expire in January.

So could extended unemployment benefits. They have been a key source of income for many people out of work for more than six months.

Nor is the economy likely to get a lift from the depressed housing market. Typically, home construction drives growth during an economic recovery. But builders have been contributing much less to the economy this time.

Wyss said that the collapse of housing had probably depressed annual growth by as much as 1.5 percentage points in the past two years.

Paul Ashworth, chief U.S. economist for Capital Economics, predicts that growth will cool in the fourth quarter and next year.

"While our baseline forecast does not include an outright contraction, we expect GDP growth to average a very lackluster 1.5% next year," Ashworth said in a note to clients.

Other economists are a bit more optimistic. The breakthrough in Europe could help, as long as a final deal is implemented. At a minimum, that would remove what many economists had considered a major threat to the U.S. economy.

Few are changing their forecast based on the deal because they had already assumed an agreement would be reached.

"The Europeans haven't solved their long-term problems, but they did address the near-term issues and that helps support the belief that we will be able to dodge a U.S. recession," said Mark Zandi, chief economist at Moody's Analytics.

Zandi forecasts growth of 1.9 percent for all of 2011 and 2.7 percent in 2012.

Economists think growth in consumer spending, which accounts for about 70 percent of economic activity, will be restrained until incomes start growing at healthier levels. That is unlikely until hiring picks up.

Consumers powered much of the growth in the third quarter. They spent at an annual rate of 2.4 percent. Many bought more furniture and clothing.

And spending on services rose 3 percent, the most in more than five years. Much of the gain was due to consumers paying more for health care and to cool their homes during an unseasonably hot summer.

Still, spending rose even though after-tax incomes adjusted for inflation fell at a rate of 1.7 percent in the summer. It was the biggest decline since the third quarter of 2009 -- just as the recession was ending.

Businesses also helped boost third-quarter growth by stepping up their investment in equipment and software. That category surged 17.4 percent -- nearly three times the rate from spring. They also invested more in building, a sign that some businesses could be expanding despite the sluggish economy.

But what would help most is if those businesses hired workers.

"With consumers and businesses spending and exports still growing, the expansion is broad-based and sustainable," said Joel Naroff of Naroff Economic Advisors. "If we can only get some better job gains, confidence will begin to return, and we can accelerate the recovery."

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