Economy Shrinks Due to Military Cuts

Posted: Jan 30, 2013 11:34 AM
A release from the Bureau of Economic Analysis today surprised analysts when the top-line number showed that the economy shrunk in the last quarter of 2013 by a slight 0.1%. While small, it was unexpected. This marks the first time the American economy has shrunk since the end of the 2008 recession.

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 0.1 percent in the fourth quarter of 2012 (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 3.1 percent.

The downturn in real GDP in the fourth quarter primarily reflected downturns in private inventory investment, in federal government spending, in exports, and in state and local government spending that were partly offset by an upturn in nonresidential fixed investment, a larger decrease in imports, and an acceleration in PCE.

A 22% decline in federal military spending drove the economic contraction. Nonmilitary spending by the federal government increased by 6%, but clearly does not offset the decline in military spending cuts.

One possibility for why defense spending declined so sharply is the looming threat of the budget sequester brought on by 2011's Budget Control Act. The Department of Defense has been threatened with fairly steep budget cuts, which they may have attempted to make up for in Q3 2012 before paring back in Q4.

That is, the Defense Department was facing the prospect of losing additional money that had already been budgeted over multiple years but hadn’t been spent. That led to a big spending spree before the end of the fiscal year, which was followed, inevitably, by a big drop in the October through December.

The March budget sequester is still scheduled to take place, and the Congressional Budget Office estimates that the defense spending cuts will touch off a 0.4% drop in GDP. Members of Congress from both sides of the aisle will have to agree on some sort of package to delay the cuts. A potential recession might get them to agree.

The GDP report wasn't all bad, though. As Megan McArdle reports:

The good news, such as it is, is that personal consumption spending and investment were humming along, growing 2.2% and 8.4%, respectively. The boost in personal spending was driven mostly by durable goods, which probably means that people are reaching the limits of hoarding--they've pushed the old car along an extra five years, put up with the oven that doesn't always work, and gone without a dishwasher, but they're now having to replace some stuff.

This could touch off a recovery, though as Megan writes, the lack of consumer confidence could spell trouble as well.

The BEA places a particular importance on how unsure they are of their estimates, however. So this number could still move in either direction.

The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4 and the "Comparisons of Revisions to GDP" on page 5). The "second" estimate for the fourth quarter, based on more complete data, will be released on February 28, 2013.

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