For the first time since the Great Recession, the nation's gross domestic product contracted in the fourth quarter, declining 0.1% and falling well short of expectations, the Commerce Department said Wednesday.
GDP, the broadest measure of the nation's economic health, had climbed 3.1% in the third quarter. The consensus for Q4 GDP was 1% growth.
The first decrease in GDP in 3 1/2 years resulted largely from a steep decline in military spending with sequestration looming and lower company inventories as businesses curtailed investments and expansions amid fiscal cliff fears and higher taxes.
Some economists also pointed to Superstorm Sandy, budget battles and debt ceiling debates as additional culprits.
Annual GDP Growth for 2012
For all of 2012, the Commerce Department said, the U.S. economy grew at a rate of 2.2%, up from 1.8% the previous year, but down from 2.4% in 2010.
Economists agree a healthy GDP falls somewhere between 2% and 3%.
The decline in the GDP notwithstanding, the Commerce Department report also included some positive signs about the economy.
Taking Pentagon cuts and the slowdown in business spending out of the equation, fourth-quarter GDP growth would have been around 2.5%, approaching Q3's rate of 3.1%. The third quarter got a boost from businesses stockpiling inventory and a 13% increase in defense spending.
Speaking of the Q4 GDP, Paul Edelstein, director of financial economics at IHS Global Insight in Lexington, MA, told Bloomberg News, "The number isn't as bad as it looks. This really was a story about a payback in national defense spending. Consumer spending growth picked up, fixed investment was fairly strong."
Consumer spending, which accounts for as much as 70% of the U.S. economy and is the dominant driver of growth, advanced 2.2% in Q4, up from 1.6% and 1.5% for the third and second quarters, respectively.
However, it's yet to be seen how consumers will respond to the end of the Payroll Tax Holiday. The tax increase will cut paychecks this year by about 2%, meaning someone earning $50,000 a year will have about $1,000 less in disposable income.
In a sign Americans are already feeling the pinch from less take-home pay, a key measure of consumer confidence tumbled in January, the Conference Board reported.
Private Sector and Defense Spending
A sharp decline in government spending had the biggest impact on Q4 GDP.
After a vigorous 3.9% increase in the third quarter, government spending shrank 6.6% in Q4, mostly due to a 22.2% drop in defense outlays. For Q3, by contrast, defense spending had spiked 12.9%.
In preparation for possible across-the-board spending cuts that could force the Defense Department to cut spending $43 billion over seven months, the military has already laid of thousands of temporary workers, implemented hiring freezes and canceled some ship repairs. The department also has warned employees to expect furloughs.
Plus, the Pentagon is currently running on funds allocated from the Treasury via "extraordinary measures" instead of a congressionally approved budget plan as lawmakers wrangle over raising the debt ceiling.
Private sector investment also dropped in the fourth-quarter, by 0.6%, the first decline in seven quarters, a result of less spending on office buildings, warehouses and other business infrastructure.
Lower inventory investment clipped 1.27 percentage points off the Q4 GDP, a result of companies piling up inventories in the third quarter and slower production in the final quarter as businesses rebalanced.
Also weighing on business growth was the slump in exports (down 5.7%), which fell faster than imports (down 3.2%).
Resilient markets shrugged off the weak and disappointing GDP number, anticipating the decline is temporary. With less than an hour left in the trading session, all three major indexes were little changed.
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