US economy shrinks at fastest rate since 1980s

The US economy had its worst three months in more than a quarter of a century, according to the long-awaited measure of GDP for the final quarter of 2008.

Business slashed investment and consumers further drew in their horns, causing the world's largest economy to contract at an annualised rate of 3.8 per cent.

The headline figure was not as bad as economists had predicted, but the underlying report showed how manufacturers couldn't cut production fast enough to reflect slumping demand – and that presages another big decline in the early months of this year.

"Domestic demand – what consumers and businesses and government actually spent – fell 5.1 per cent," said Kevin Logan, senior US economist at Dresdner Kleinwort. "Given falling demand, you would think that inventories would fall, too, but goods were still going on the shelves. Producers couldn't cut production as fast as demand was falling, which suggests that we will get another sizeable decline in production in this quarter as a result."

Consumers are adjusting to the fact that they have less wealth in the stock market and in housing, Mr Logan said. Following an annualised 3.8 per cent decline in consumer spending in the third quarter, spending contracted a further 3.5 per cent in the fourth.

And businesses scaled back investment by 20.1 per cent, a sharper rate than at any point since 1980. The fourth quarter reflected the aftermath of the financial panic of mid-September, when credit to businesses threatened to dry up and when consumers became increasingly fearful for their jobs.

The 3.8 per cent contraction in overall GDP was the largest since the recession of the early Eighties, when the Federal Reserve was trying to stamp out inflation. This time, inflation concerns have evaporated, and yesterday's GDP numbers showed that consumer prices fell at a 5.5 per cent annual rate, the biggest drop on record.

The US government calculates GDP growth as an annualised rate, which takes the quarter-on-quarter change in the size of the economy and multiples it by four. European countries, including the UK, typically publish the raw quarter-on-quarter change.