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First Quarter GDP Growth Falls Flat

The economy grew in the first quarter of 2013, but not by as much as most economists expected. The disappointing numbers suggest that federal austerity measures are having a bigger impact on the economy than most people have realized.

[BROWSE: Political Cartoon on GDP and the Economy]

Gross domestic product grew by 2.5 percent in the first quarter, which isn't bad, except that economists had been expecting growth of 3 percent or more. That followed anemic 0.4 percent growth in the fourth quarter of 2012. Since the economy was dominated by worries about the "fiscal cliff" at the end of 2012, economists figured a pullback in economic activity late last year would be offset by my liberal spending at the start of 2013. That didn't quite happen.

Consumer spending remained strong in the first quarter, which is a bit of a puzzle because disposable income fell by 4.4 percent. Income declined for two reasons: tax hikes that went into effect at the start of the year, and accelerated dividend payments at the end of 2012 (before higher taxes kicked in) distorted the numbers. The bottom line is that Americans are sustaining their spending by saving less, a tradeoff that probably can't last.

The main drag on growth was a cutback in government spending. State and local spending fell a little, but the big hit came from a drop in federal spending, mostly on defense. That's largely because of the spending cuts known as the "sequester," which went into effect March 1. That big decline is the most significant evidence so far that budget battles in Washington are hitting the real economy, with more to come. "Economic momentum is weak as the economy prepares to be hit by more severe fiscal drag coming from the sequester," economist Scott Hoyt of Moody's Analytics wrote in a summary of the GDP report.

[READ: Fourth-Quarter GDP Revised Upward]

Investors are likely to interpret the GDP numbers as bad news because they suggest the underlying economy is more vulnerable to Washington budget battles than anybody would like. The stock market has been hitting new highs recently, in spite of middling or discouraging economic reports, because investors basically believe a robust recovery is coming soon. Some Wall Street analysts have begun downplaying the role of Washington in the economy, while highlighting the resilience of the private sector. The GDP numbers may moderate such views.

There is an upside. The Federal Reserve has remained skeptical of the recovery and mindful of ample warning signs, which is why it has continued its easy-money policies without disruption. With economic growth now weaker than expected, recent talk of an early end to the Fed's policies may subside for a while, with the Fed continuing to pump money into the economy for the foreseeable future. Fed policies have provided a lift to stock prices during the last four years and will probably continue to offset downward pressure. The GDP numbers are an advance estimate, and could be revised up or down as more data becomes available. Economic reports are unusually volatile at the moment, because of the abrupt changes recently in federal tax-and-spending policy. Expect that volatility to extend to the stock and bond markets during the next several months, as investors try to figure out what's really going on with the economy.

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It does seem obviously, however, that a slowdown is underway, with second-quarter GDP likely to be much lower than in the first quarter, for a number of reasons. For one, the economy is now bearing the full force of the sequester, which will take about $85 billion out of the GDP this year. And consumers are finally feeling the effect of the tax hikes that reduced paychecks at the start of the year.

Most forecasts for second-quarter growth are around 1.5 percent or lower, which is very weak. The April unemployment report, due out May 2, will be the next key snapshot into the health of the economy. If employers created fewer than 100,000 jobs in April, it will be another sign of a major slowdown. Things will get better at some point, but that may not come till the end of 2013 or the start of 2014.

Rick Newman's latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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