Economy shrinks 0.1% in Q4

(MoneyWatch) The nation's gross domestic product -- the value of all goods and services produced -- fell at an annual rate of 0.1 percent in the fourth quarter, a big downshift from 3.1 percent in the third quarter. During the quarter federal spending plummeted by 15 percent, led lower by the biggest cut in defense spending in 40 years. The reduction in government spending, along with a pullback in private business inventories, reduced growth by 2.6 percent over the quarter.

There were some small positives within the report: Consumer spending increased by 2.2 percent, up from 1.6 percent in the third quarter and business spending was up 8.4 percent after declining in the previous quarter. Growth for all of 2012 was 2.2 percent, ahead of 2011's growth of 1.8 percent.

Economists had predicted a weakened pace, but few thought the economy would actually shrink after 13 consecutive quarters of growth. Because this is the first of three readings on the quarter, the number is subject to revisions, so maybe there will be an improvement. Still, there's no getting around the fact that the U.S. is still mired in a slow growth recovery. According to the Wall Street Journal, the real rate of economic growth during the recovery has averaged about 2.2 percent, which is about half the 4.23 percent average rate in the past 10 recoveries and well below the average annualized GDP since World War II of 3 - 3.5 percent.

Perhaps more worrisome is what lies ahead. The 15 percent reduction in government spending may be a mere pittance when compared to the $110 billion of across-the-board spending cuts ("sequestration") that are set to begin on March 1. According to Macroeconomic Advisors, the sequester could shave 0.7 percent points from 2013 GDP.

Those spending cuts come on top of the 0.5 percent reduction of growth caused by the recent payroll tax increase. Capital Economics attributed the recent drop in the Conference Board's Consumer Confidence index to a 14-month low to the payroll tax increase and predicts that "household income is likely to restrain first-quarter consumption growth." As a result of both the payroll tax increase and spending cuts, most economists have downgraded growth expectations for the year.

It's instructive to note that the coming debate about the nation's debt and deficit severely impact prospects for future growth. Before deficit hawks extol the virtues of a country living within its means, it may be wise to look at Spain's most recent report on economic growth. The preliminary reading of Spanish GDP fell 0.7 percent in the fourth quarter from the third quarter and 1.8 percent from the same period the previous year, as new rounds of eurozone imposed austerity depressed the economy. Is the U.S. ready to trade debt reduction for economic growth?

Editor's note: CBS MoneyWatch initially published an Associated Press story on the GDP report, which we have since replaced with this staff-written article. You can find the initial AP report and reader comments here.