Economy Expands 3.5 Percent in Third Quarter, Biggest Growth in 2 Years

The economy grew at a 3.5 percent pace in the third quarter, the best showing in two years, fueled by government-supported spending on cars and homes.

The Commerce Department's report Thursday delivered the strongest signal yet that the economy entered a new, though fragile, phase of recovery.

The report, though promising, does not mark the end of the recession, which by definition can only come with two consecutive quarters of economic growth.

Treasury Secretary Timothy Geithner reacted to the report Thursday, saying he sees positive signs that the economy is recovering, although the recession remains "alive and acute" for families dealing with unemployment and facing home forceclosure.

In testimony before the House Financial Services Committee, Geithner said that Americans were saving much more and borrowing less from the rest of the world.

Many analysts expect the pace of the budding recovery to be plodding due to rising unemployment and continuing difficulties by both consumers and businesses to secure loans.

Still, the much-awaited turnaround ended the streak of four straight quarters of contracting economic activity, the first time that's happened on records dating to 1947.

It also marked the first increase since the spring of 2008, when the economy experienced a short-lived uptick in growth.

The third-quarter's performance -- the strongest since right before the country fell into recession in December 2007 -- was slightly better than the 3.3 percent growth rate economists expected.

Armed with cash from government support programs, consumers led the rebound in the third quarter, snapping up cars and homes.

Consumer spending on big-ticket manufactured goods soared at an annualized rate of 22.3 percent in the third quarter, the most since the end of 2001. The jump largely reflected car purchases spurred by the government's Cash for Clunkers program that offered a rebate of up to $4,500 to buy new cars and trade in old gas guzzlers.

The housing market also turned a corner in the summer. Spending on housing projects jumped at an annualized pace of 23.4 percent, the largest jump since 1986. It was the first time since the end of 2005 that spending on housing was positive.

The government's $8,000 tax credit for first-time home buyers supported the housing rebound. Congress is considering extending the credit, which expires on Nov. 30.

The collapse of the housing market led the country into the recession. Rotten mortgage securities spiraled into a banking crisis. Home foreclosures surged. The sector's return to good health is a crucial ingredient to a sustained economic recovery.

Brisk spending by the federal government, led by efforts to stimulate the economy and on defense, also played into the third-quarter turnaround. Federal government spending rose at a rate of 7.9 percent in the third quarter, on top of a 11.4 percent growth rate in the second quarter.

In other encouraging developments, businesses boosted spending on equipment and software at a 1.1 percent pace in the third quarter, the first increase in nearly two years.

Third-quarter activity also was helped by increased sales of U.S.-made goods to customers overseas, as economies in Asia, Europe and elsewhere improved. The cheaper dollar is aiding U.S. exporters, making their goods less expensive to foreign buyers. Exports of U.S. goods soared at an annualized rate of 21.4 percent in the third quarter, the most since the final quarter of 1996.

Businesses, meanwhile, reduced their stockpiles of goods less in the third quarter, after slashing them at a record pace in the second quarter. With inventories at rock-bottom levels, even the smallest increase in demand probably will led to factories boosting production. This restocking of depleted inventories is expected to help sustain the recovery in the coming months.

Even with the third-quarter improvement, the economy isn't out of the woods yet.

Federal Reserve Chairman Ben Bernanke and members of President Barack Obama's economics team have warned that the nascent recovery won't be robust enough to prevent the unemployment rate -- now at a 26-year high of 9.8 percent -- from rising into next year.

Economists say the jobless rate probably nudged up to 9.9 percent in October and will go as high as 10.5 percent around the middle of next year before declining gradually. The government is scheduled to release the October jobless rate report next week.

Rising unemployment and continuing difficulties by both consumers and businesses to secure loans are among the forces likely to weigh on the recovery.

With joblessness growing and wages dipping slightly in the third quarter, consumers are expected to turn more restrained in the months ahead. That would put a much heavier burden on America's businesses to keep the recovery going.

The Associated Press contributed to this report.