US Federal Reserve Headquarters, Washington DC.

Goldman Sachs, the US investment bank, said today that in reaction to recent US economic data including last Friday's December jobs report, that it expects a recession this year with the Fed responding with substantial  cuts to the federal funds rate.

“Over the past few months, we have become increasingly concerned that the US housing and credit market downturn would trigger not just a growth slowdown and substantial Fed easing — our long-standing view — but also an outright recession. The latest data suggest that recession has now arrived, or will very shortly,” Goldman said in a research note.

Goldman is also forecasting a decline in consumer spending, which didn't happen in the 2001 recession, in the aftermath of the dot-com bust.

The bank refers to the recent rise in the unemployment rate by a third of a percentage point from the cyclical low. Such a move has historically been associated with recession, usually begining within three months.

Dr. Peter Morici's comments on Friday's December 2007 jobs report: US Economy adds only 18,000 Jobs in December: Economy skidding as Fed faces a Crisis of Confidence

A recession is defined as two successive quarters of falls in the Gross National Product - a measure of the output of goods and services in the economy.

Goldman Sachs says that the recession shouldn’t last more than three quarters and should be relatively mild. Goldman says that it is optimistic because the economists expect the Federal Reserve to cut the fed funds rate to 2.5% by the end of the year from the current 4.25%. They also expect a government package of fiscal stimulus and continued strong exports offsetting the weakness.

“Despite our near-term concerns, we are quite optimistic about the economy’s longer-term prospects,” Goldman said. “We believe that most of the recent weakness in productivity is cyclical and estimate that real GDP can grow at close to a 3% trend rate without igniting inflationary pressures.”