The U.S. economy contracted by a fraction of a percent in the final quarter of last year, catching investors off guard. According to a Commerce Department report released yesterday GDP contracted by .01 percent at the end of 2012, the weakest economic report since the second quarter of 2009. The report cites declining military spending and exports as some of the many reasons for decline. In addition, the political impasse in Washington over the “fiscal cliff” was blamed for frustrating investment.
Some information in the report was cited to dispel concerns about a return to recession. For example, investment in residential housing jumped 15.3 percent, and equipment and software purchases by businesses rose 12.4 percent. However, the 22.2 percent drop in military spending is the single largest drop in 40 years represents a significant amount of federal spending, and that decline alone helped push the last quarter into negative growth. Along with a decline in the consumer confidence index this month news of negative growth sent stocks down this morning, though the market rallied later.
With unemployment remaining at 7.8 percent and forecasts for growth reigning back estimates for the first quarter of 2013, Congress and President Obama will have to achieve a more fair process that leads to more stable budgeting. The so-called “fiscal cliff” cannot be resolved unless Republicans compromise on a sensible tax plan and Democrats stand their ground on further austerity cuts. Although a balance has to be struck between taxes and spending, the report clearly shows that declines in government spending directly contribute to slow growth. This is because spending cuts are more likely than not to undermine effective demand further and frustrate solid growth.