Wednesday the Commerce Department released its advance estimate for fourth-quarter Gross Domestic Product (GDP). And the report was a doozy: The U.S. economy actually contracted in the fourth quarter! While this report is typically a market mover, the major indices held remarkably steady following this news. What has the nation’s top economists, analysts and investors so calm? I have your answer below.
Why Does It Matter?
Gross Domestic Product is the broadest measure of economic activity, covering consumer spending (consumption), investment, net exports, government purchases and inventories. Consumer spending is by far the largest component, totaling roughly two-thirds of GDP. When we talk about the GDP growth rate, we’re referring to annualized quarterly percent changes
What Was So Significant About the Report?
In the fourth quarter, GDP fell at a 0.1% annual rate—this is the first time that the economy has contracted in three and a half years. This came below economists’ expectations (they predicted 0.1% growth) and also represents a significant slowdown from the 3.1% growth we saw in the third quarter.
What Caused the Drop?
The main culprits were government spending cuts, especially in the defense sector, and slower inventory growth. In total, these two factors subtracted 2.6 percentage points from GDP.
The Silver Lining
The headline figure notwithstanding, there were a lot of positive details in this report. To start, while one-time factors were the main drag on GDP, we’re seeing long-term improvement in some crucial pockets of the economy. For example, the holiday shopping season contributed to robust consumer spending in the fourth quarter—this alone added 1.5 percentage points to GDP. At the same time, American businesses ramped up their investment efforts and this contributed 1.1 points.
The Bottom Line
So there are several good reasons that Wall Street has remained calm in the wake of this surprising report. Despite the fourth-quarter decline, the economy still grew 2.2% for the entirety of 2012—an improvement over the prior year’s 1.8% growth rate. But the report has put Washington in the hot seat once again. Considering that much of the drop was due to government spending cuts, there is going to be a lot of pressure on Congress to avoid the automatic cuts scheduled in March.