WASHINGTON – The economic recovery is now consistently picking up speed, and American consumers are the ones pushing the gas pedal. They increased their spending late last year at the fastest pace since 2006.
The question now is whether they can spend enough this year to make the economy grow even faster and finally bring down unemployment. It's up to them because the housing market and government spending aren't offering much help.
A more active consumer was the main reason the economy grew at an annual rate of 3.2 percent in the final three months of 2010, the Commerce Department said Friday. It was up from 2.6 percent the previous quarter and the best since the start of last year.
That level of growth would be great news in a healthy economy that only needed to hold steady. But with unemployment still at 9.4 percent a year and a half after the Great Recession, steady is not good enough. By some estimates, the economy would need to grow 5 percent for a whole year to significantly bring down the unemployment rate.
Still, the recovery has gained steam since a difficult patch last spring. Economists now think 2011 will be a pivotal year when consumers can finally be counted on to power the economy to stronger growth.
A one-year cut of 2 percentage points in the Social Security payroll tax is a big reason why economists predict Americans will keep spending enough that the economy will grow more strongly this year.
"Consumers are the most powerful cylinder the economy has, and finally it is firing," said economist Sung Won Sohn at California State University. "Consumers will be picking up the slack this year as the government stimulus fades."
After the recession ended, Americans became cautious about spending. That changed at the end of last year. They increased spending by a 4.4 percent annual rate from October to December, including holiday splurges on furniture, appliances, cars and clothes.
Besides the tax cut, the stock market is at its highest point since mid-2008 and unemployment has come down from its post-recession peak. Both factors could make people feel more comfortable about spending.
Economists think consumer spending will rise 3.2 percent or more for all of 2011, almost double last year's rate. Consumer spending accounts for roughly 70 percent of overall economic activity.
"At this point, it looks like consumers will finally be full-fledged contributors to the economy's growth," said economist Jim O'Sullivan of MF Global.
The recovery has a tough road ahead, though. Economists surveyed by The Associated Press predict the unemployment rate will rise to 9.5 percent in January and fall only to 8.9 percent by the end of this year.
For all of last year, the economy grew 2.9 percent, the most since 2005. The year before, the economy had suffered its worst contraction since World War II. All told, the economy produced about $13.4 trillion worth of goods and services in 2010, a record.
In a separate report, the Labor Department said wages and benefits rose 2 percent last year, the second-smallest increase in nearly three decades and only marginally better than 2009. Even though employers are expected to hire more this year, they have little incentive to pay more because competition for jobs is so fierce.
And with their paychecks growing only marginally, Americans are saving less. The savings rate dropped to 5.4 percent, from 5.9 percent in the quarter before. Economists predict people will save even less this year.
The economy depends heavily on consumer spending because federal stimulus aid is fading and many businesses are spending less money to replenish their stockpiles.
Businesses spent about $7 billion on inventories in the last three months of the year. That's far less than the $121 billion spent in the three months before, when factories were boosting production of goods for businesses that had let their stockpiles shrink. From October through December, that manufacturing output slowed. In fact, it subtracted from growth instead of adding to it, leaving consumers to pick up the slack.
Exports grew faster in the last three months of the year and are expected to rise even more this year, helping the economy. Economists also expect double-digit growth in spending on equipment and software by businesses. Tax breaks included in the compromise reached between President Barack Obama and Republicans late last year will leave companies with money to spend.
Spending on home building rose at the end of last year, after a sharp cut in the prior quarter. Usually housing construction is a big contributor to growth after recessions as low interest rates spur buyers. But in this recovery, credit is hard to get. And consumers are still wary of making major financial commitments.
"After worries last year that the economy might be stalling, we turned a corner," said Mark Zandi, chief economist at Moody's Analytics. "I think we will have a self-sustaining economic expansion in 2011."
Government spending stopped being a source of growth for the economy at the end of last year. It dipped 0.6 percent in the October-to-December quarter, the first drop since the start of 2010.
The pullback reflected cuts in spending by the federal government on defense and by state and local governments, which are struggling with budget shortfalls. Most of the benefit of the federal stimulus package came last year.
What's left to spend by the government on repairing roads and bridges and on other infrastructure projects will likely wind down next year, economists said.
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