Wednesday, January 30, 2013

Economy Unexpectedly Shrank in 4th Quarter

Real GDP fell 0.1% in the fourth quarter of 2012, marking the first decline since the US economy exited the 2007-2009 recession. Although the headline decline is somewhat shocking, the fundamental data is surprisingly strong. The decline was driven by one-time events, some of which may be reversed, boosting growth in coming quarters. The majority of the decline was driven by the largest fall in federal defense spending in over 40 years.

Growth in the fourth quarter slowed significantly from the 3.1% growth seen in the third quarter. The fourth quarter’s decline brought down 2012 GDP growth to 2.2% for the year.

The decline in the fourth quarter was driven primarily by reduced government spending, inventory drawdown and drag from exports. Federal defense spending fell at a 22% annual rate in the fourth quarter, producing a 1.3% drag on GDP growth. The cuts came primarily from outlays other than military personnel, suggesting that the military has been preparing for the looming sequestration.

The drawdown on inventories provided a 1.3% drag on growth in the fourth quarter, however is a positive sign for growth going forward. As inventories decline, it means more is being consumed than is being produced. This means that in coming months production will need to be ramped up to meet demand and rebuild inventories.

Finally, net exports provided a 0.3% drag on growth as continued weakness overseas hampers our growth.

Despite the strong declines in a number of categories, the fundamentals actually improved in the third quarter. Personal consumption added 1.5% to GDP growth, up from 1.1% the previous quarter. Fixed investment also improved notably, rising to 1.2% from 0.1% the previous quarter. Both residential investment and non-residential investment improved. These two areas are where we can see sustainable growth and will be the pillar of a sustainable recovery. Their continued strength suggests the fourth quarter results are unlikely to be repeated.

Read the BEA release.

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