Although the initial result was better than economists expected, the figure is likely to be revised even lower in the months ahead and some believe the economy is contracting in the current quarter at an even faster pace.
The new figure, released Friday by the Commerce Department, showed the economy sinking at a much faster clip in the October-December period than the 0.5 percent decline logged in prior quarter.
Economists had forecast an even worse fourth-quarter performance - a staggering 5.4 percent rate of decline - but the results were still grim.
The report provided clear evidence of the economy's rapid deterioration as the housing, credit and financial crises - the worst since the 1930s - feed on each other. It's a vicious cycle that has proven difficult for Washington policymakers to break.
"The recession is still in full swing unfortunately. And we're going to see more unemployment - all the layoff announcements - probably through the first half of this year," said Stuart Hoffman, vice president of PNC Financial Services, told CBS News correspondent Anthony Mason.
Fearful of losing their jobs, Americans cut their spending more than 3 percent in the fourth quarter, while the savings rate more than doubled to nearly 3 percent, Mason reports. Spending on big-ticket "durable" items like appliances, furniture and cars plunged more than 22 percent.
A 7.1 percent annualized cutback in spending on "nondurables," such as food and clothing was the deepest since the end of 1950.
Companies cut back too. Business investment fell 20 percent, the biggest drop since 1980. Exports plunged nearly 20 percent as business also dried up abroad.
"The economic situation is dire," said David Cote, CEO of Honeywell, the global conglomerate that makes everything from airplane technology to turbochargers to thermostats, in an interview with Mason.
His take on the temperature of the economy: "It's almost the great recession at this point."
The 3.8 percent annualized drop in GDP marked the weakest quarterly showing since a 6.4 percent annualized plunge in the first quarter of 1982, when the country was suffering through a severe recession.
For all of 2008, the economy grew by just 1.3 percent. That was down from a 2 percent gain in 2007 and marked the slowest growth since the last recession in 2001.
To jolt life back into the economy, President Barack Obama and Congress are racing to enact a multibillion-dollar package of increased government spending that includes big public works projects and tax cuts. The House passed a $819 billion package on Wednesday and the bill is working its way through the Senate. Economists say the money needs to be quickly pumped into the economy to help stop the free-fall.
A massive pullback by consumers is expected to play a prominent role in the economy's worsening backslide. They are cutting back on spending as jobs disappear and major investments - homes, stocks, retirement accounts - tank in value.
Big cutbacks by homebuilders - reeling from the collapsed housing market - and other companies also figured into the fourth-quarter weakness. Homebuilders slashed spending at a 23.6 percent pace, even deeper than the 16 percent annualized cut in the prior three months.
Spending by businesses on equipment and software dropped at a whopping 27.8 percent annualized pace in the fourth quarter, the most since early 1958.
Meanwhile, U.S. exports, whose growth earlier last year helped to keep the economy afloat, turned negative. Exports plunged at a rate of 19.7 percent in the fourth quarter, the most since the third quarter of 1974. Economic slowdowns in other countries has cut into demand for U.S goods and services.
The economy plunged deeper into recession despite a $700 billion financial bailout program run by the Treasury Department and a slew of radical programs by the Federal Reserve and others designed to bust through a debilitating credit clog and get banks to lend more freely. The Fed last month slashed a key interest rate to a record low, and on Wednesday signaled that it would use other unconventional tools to turn the economy around.
Trying to survive the downturn, businesses are scrambling to cut costs and that's taking a painful toll on the nation's labor market.
The unemployment rate jumped to a 16-year high of 7.2 percent in December and could hit 10 percent or higher at the end of this year or early next year. A staggering 2.6 million jobs were lost last year. Another 2 million or more jobs will vanish this year, economists predict.
This week alone, tens of thousands of new layoffs were announced by companies including Ford Motor Co., Eastman Kodak Co., Black & Decker Corp., Boeing Co., Pfizer Inc., Caterpillar Inc., Home Depot Inc. and Target Corp.
On Wednesday, Honeywell's Coate was part of a group of top executives at the White House who told Obama that the jolt the economy needs is a stimulus package to get people spending and a rescue plan to get the banks lending, Mason reports.
"It's going to be expensive," Coate said. "I think that's one that'll get measured in trillions, not hundreds of billions."
As expensive as that sounds, Coate says, the cost of doing nothing will be even greater. Many economists are forecasting the drop in GDP this quarter will be even be worse than last.