This had better be a one time contraction or we have the biggest disconnect with markets that we have seen in years. Thank you Ben!

  • January 30, 2013, 11:16 a.m. ET

U.S. Economy Unexpectedly Contracts in Fourth Quarter

Private-Sector Hiring Rose by 192,000 in January, ADP Reports


U.S. economic momentum screeched to a halt in the final months of 2012, as lawmakers’ struggle to reach a deal on tax increases and budget cuts likely led businesses to pare inventories and the government to cut spending.

The nation’s gross domestic product shrank for the first time in 3 1/2 years during the fourth quarter, declining at an annual rate of 0.1% between October and December, the Commerce Department said Wednesday.

It was the first time the broad measure of all goods and services produced by the economy contracted since the recovery from the financial crisis began. Economists surveyed by Dow Jones Newswires had expected 1.0% annualized growth.


The decline reflects worries about the so-called fiscal cliff. The economy reversed from a 3.1% pace of growth in the third quarter largely because federal government spending fell by 15% and private business, likely fearing slack in demand, let inventories dwindle.

“Think of it as a giant hand holding down the economy,” said Tim Hopper, chief economist at TIAA-CREF. “The underlying fundamentals are quite strong.”

With the worst effects of the pending budget cuts and tax increases averted after Congress and the White House reached an agreement this month, Mr. Hopper said he expects the economy to return to moderate growth this year.

However, tax increases and possible federal budget cuts could weigh on advances in the first half of the year, said Stuart Hoffman, chief economist at PNC Financial Services Group . Exports are still a concern because of the recession in Europe.

“The economy has less momentum going into 2013 than initially thought, making it vulnerable to external shocks,” Mr. Hoffman said in a research note. “A turnaround in the housing market will be a key support to the economy this year.”

For all of 2012, gross domestic product expanded 2.2%, an improvement compared with 1.8% growth in 2011.

The decline in federal spending last quarter was the largest drop since 1973. Spending at all levels of government fell 6.6% in the period.

That drop was the primary culprit for the economy contracting, said Alan Krueger, chairman of the White House’s Council of Economic Advisers.

“Several private-sector components of GDP continued to make positive contributions,” Mr. Krueger said. “A likely explanation for the sharp decline in Federal defense spending is uncertainty concerning the automatic spending cuts that were scheduled to take effect in January,” and are now set for March 1.

Republican leaders, however, say they will push for additional budget cuts in order to rein in growing federal debt.

“Clearly, we need to address spending,” Senate Republican Leader Mitch McConnell (R., Ky.) said Wednesday. “There’s simply no other way to solve the problem.”

News of economic contraction may weigh on Federal Reserve policy makers, who are meeting this week.

To prop up the feeble growth, Fed officials in December said they expected to keep short-term rates near zero until the unemployment rate falls to 6.5% or lower. At 7.8% in December, the unemployment rate remains above historic norms.

The central bank will announce its latest policy moves later Wednesday. Low inflation gives the Fed leeway to pursue continued economic stimulus. The price index for personal consumption expenditures—the Fed’s preferred gauge for inflation—advanced at an annualized 1.2% rate in the fourth quarter.

There were bright spots for the economy last quarter. Americans opened up their wallets during the holiday shopping season. Personal consumption expenditures increased 2.2%, compared with 1.6% in the third quarter.

The housing market advanced as residential fixed investment, which includes spending on home improvements, grew by 15.3% in the fourth quarter.

Business investment also grew steadily, rising 8.4%, despite uncertainty about U.S. fiscal policy.

But those gains were offset by negatives, including a decline in inventories. That often-volatile category subtracted 1.27 percentage points from fourth-quarter GDP after adding 0.73 points to third quarter growth.

Real final sales—GDP less changes in private inventories—increased 1.1% in the fourth quarter, compared with a 2.4% gain in the prior period.

Trade was also a drag on the economy, as exports fell 5.7% during the quarter.

Superstorm Sandy, which struck the Northeast in late October, likely had a bearing on fourth-quarter output, but the Commerce Department wasn’t able to provide an estimate of its effect on GDP. Other data have suggested Sandy slowed factory production, increased layoffs and closed some shops in the weeks after the storm, but rebuilding efforts likely added growth later in the time period.

The Commerce Department estimated that Sandy destroyed $35.8 billion in private assets and $8.6 billion in government property. The agency said it expects private insurance companies to pay out benefits for $20.6 billion in losses and said the federal government’s flood insurance program will pay an additional $7.5 billion.

A drought in the Midwest also took a toll on the economy. Hot weather reduced farm-inventory investment by $24 billion in the fourth quarter. But after adjusting for inflation, farm inventories were still a positive contributor to GDP for the first time in 2012.

Write to Eric Morath at and Kathleen Madigan at