The federal government helped bring the economic recovery to a virtual halt late last year as cuts in military spending and other factors overwhelmed the Federal Reserve’s expanded campaign to stimulate growth.
Disappointing data released Wednesday underscore how tighter fiscal policy may continue to weigh on growth in the future as government spending, which increased steadily in recent decades and expanded hugely during the recession, plays a diminished role in the United States economy.
Significant federal spending cuts are scheduled to take effect March 1, and most Americans are also now paying higher payroll taxes with the expiration of a temporary cut in early January.
The economy contracted at an annual rate of 0.1 percent in the last three months of 2012, the worst quarter since the economy crawled out of the last recession, hampered by the lower military spending, fewer exports and smaller business stockpiles, preliminary government figures indicated on Wednesday. The Fed, in a separate appraisal, said economic activity “paused in recent months.”
Still, economists said the seemingly bleak gross domestic product report was not a sign that another recession was looming. The preliminary data showed relatively strong spending by consumers and businesses, even as military spending posted its sharpest quarterly drop in 40 years.
Forecasters expect that growth this year will rebound to a still-anemic 1.5 percent, a little lower than the pace it has managed over the last three years.
“This is the tip of the iceberg on fiscal austerity from Washington,” said Ethan Harris, co-head of global economics research at Bank of America Merrill Lynch. “It was exaggerated this quarter by the unusually large drop in defense spending, but that and higher taxes will start hurting” in the coming months.
The drop in American exports stemmed in part from a decline in economic growth in Europe, where governments have also been cutting spending in a bid to balance budgets. The parallel contractions are likely to provide fodder for economists who argue that austerity efforts have gone too far in many developed economies.
The surprisingly weak numbers could also force politicians to limit the cuts that are scheduled to take effect if Congress fails to produce a budget bargain in the coming weeks and strengthen the argument that deficit reduction is a lesser concern than job creation.
“Our economy is facing a major headwind, and that’s Republicans in Congress,” said the White House spokesman Jay Carney.
Republicans said the White House was not advancing concrete plans for creating new jobs and stimulating the economy.
“The bad GDP news makes it even more unbelievable that Obama has been ignoring job growth in his 2nd term agenda,” Reince Priebus, chairman of the Republican National Committee, posted on Twitter.
The Fed said Wednesday that it would continue its efforts to revive growth by holding short-term interest rates near zero and increasing its holdings of Treasury securities and mortgage-backed securities by $85 billion a month. Those policies aim to reduce borrowing costs for businesses and consumers.
“The committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline,” the Fed said in a statement.
Unemployment has not declined since the Fed started its latest round of purchases in September. The rate was 7.8 percent in December, the same as three months earlier. The government will report the rate for January on Friday.
Although economists expected output to decline substantially from the 3.1 percent annual growth rate recorded in the third quarter, the negative G.D.P. number still caught Wall Street off-guard. It was the weakest economic report since the second quarter of 2009, although revisions in February and March could alter the figure.
“I’m a little surprised,” said Michael Feroli, chief United States economist at JPMorgan.
Like some other observers, Mr. Feroli said there were hints the economy was performing slightly better than the headline number suggested.
The 22.2 percent drop in military spending, along with the drop in inventories and exports, outweighed more positive indicators in the private sector, he said. For example, residential investment jumped 15.3 percent, a sign that the housing sector continued to recover. Similarly, investment in equipment and software by businesses rose 12.4 percent, an indicator that companies were still spending
For the entire year, the economy grew by 2.2 percent, a slight improvement from the 1.8 percent annual rate in 2011.
Despite the unexpected contraction, investors reacted mildly to the news, with the Standard & Poor’s 500-stock index falling less than half a percent.
If it were not for the drop in total government spending, the economy would have expanded at an annual rate of 1.2 percent in the fourth quarter, said Nigel Gault, chief United States economist at IHS Global Insight.
Alan Krueger, chairman of the president’s Council of Economic Advisers, wrote in a blog post that “a likely explanation” for the plunge in military spending was concern among contractors about the automatic spending cuts, which were set to take effect on Jan. 1 but were rescheduled for March 1. The decline in federal spending follows an earlier drop in state and local spending, which fell by 3.4 percent in 2011 and 1.3 percent in 2012.
The compromise between President Obama and Congress earlier this month allowed a temporary cut in Social Security taxes to expire, which is also expected to crimp growth in the first quarter. The change will cost a worker earning $50,000 a year an extra $1,000 annually.
A consumer confidence survey released Tuesday by the Conference Board showed a sharp downturn in January, which economists attributed in part to financial anxiety arising from the reduction in take-home pay.
In the long term, government’s share of economic output “is a question of values and choices and what size you think the government should be,” Mr. Gault said. But in the short term, he said, steep cutbacks make for risky economic policy.
“We’re being more austere than we need to be,” he said. “The economy isn’t growing that fast and you don’t want to be taking away stimulus now.”