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U.S. economy contracts in 4th quarter, but details remain strong

Written By: Andrew Hedlund on January 30, 2013 No Comment
Though the economy contracted in the fourth quarter, consumer spending saw a slight increase. (Courtesy of 401(K) 2013)

Though the economy contracted in the fourth quarter, consumer spending saw a slight increase. (Courtesy of 401(K) 2013)

The U.S. Bureau of Economic Analysis released some unwelcome news Wednesday.  Gross domestic product, the broadest measure of the U.S. economy,  contracted 0.1 percent in the fourth quarter of 2012, compared with an increase of 3.1 percent in the prior three months.

But economists largely discounted the contraction, which was unexpected and the worst showing since the second quarter of 2009 when the U.S. was in recession, and pointed to a 22.2-percent drop in defense spending and inventories as reasons for the output decline.

“Obviously the headline contraction was unexpected, but the details were a lot stronger,” said Paul Ashworth, an economist at Capitol Economics. “Mostly it comes down to the factor that inventories subtracted growth and there was an enormous drop in defense spending.” He added these factors were most likely a “one-off” and not indicative of an economy headed back into recession.

Government spending overall decreased by 15 percent in the quarter, paced by the 22.2 percent drop in defense spending. Anticipation of massive spending cuts at year-end under a potential budget sequester mainly drove the drop in government spending, economists said.

“Special factors clearly exacerbated the weakness that we saw in the fourth quarter,” Mesirow Financial economists wrote in a note. “We should see some bounce back in overall growth, now that those factors have abated and are working in the other direction.”

Meanwhile, consumer spending, which makes up the lion’s share of the U.S. economy, saw an increase of 2.2 percent, an acceleration from the 1.6 percent gain of the prior quarter. The Obama administration underlined that strength Wednesday following the report.

“Although GDP is the broadest measure of economic activity,” Alan Krueger, the chairman of the Council of Economic Advisers, wrote in a White House web post,  “other indicators of economic performance suggest that the economy continued to recover in the fourth quarter, despite the impact of Hurricane Sandy and uncertainty surrounding fiscal issues.”

Whether strength from the consumer sector will continue is a matter of some debate. The expiration of President Barack Obama’s payroll tax cut, which hits lower- and middle-income families particularly hard, could decrease consumer spending by 1 percent, Ashworth said. He added this will take $100 billion annually out of the country’s economy.

Uncertainty over the fiscal situation remains as well. Congress avoided the fiscal cliff at the beginning of 2013 but delayed the sequestration, or $1.2 trillion budget cuts, and action to raise the nation’s debt ceiling, until March 1.

Ashworth said he doubts Congress and the president would let the massive budget cuts take effect permanently; rather if they occur at all it would be only for a few weeks.

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