U.S. economy contracted 3.8 percent in the 4th Quarter.  The Bureau of Economic Analysis reported that real  Gross Domestic Product (GDP) fell by 3.8 percent (seasonally adjusted annual rate) in the fourth quarter of 2008, marking the second straight quarter where the economy has shrunk.  While many forecasters had expected a much larger drop in economic activity, this decline was still the largest in 26 years.  The main contributors to the drop in GDP were declines in exports and consumer spending, a significant decline in nonresidential fixed investment, especially on equipment and software, and a continuing decline in residential fixed investment.  Net exports, which contributed positively to GDP in the second and third quarters of 2008, are no longer contributing to economic growth as the worldwide recession has dramatically decreased demand for US goods and services abroad.  The decline in exports took away 2.8 percentage points from GDP growth.  While exports declined, imports also fell due to sluggish demand as well as declining import prices, especially oil prices.  Inventory investment contributed positively to GDP (1.3 percent), but there are concerns that this increase likely reflects a dramatic drop in demand, rather than an intended increase in inventories. (See Chart)

Distressed home sales puts downward pressure on prices.  The pace of new home sales fell 14.7 percent in December to a new low and is now more than 75 percent lower than its peak in July 2005.  In all of 2008, only 482,000 new homes were sold, the worst year since 1982.  In contrast, close to 1.3 million homes were sold in 2005, the peak of new home sales.  Average and median new home prices fell sharply in December.  The median price of a new home sold in December was $206,500 compared with the median price of $247,900 in 2007. Existing home sales actually rose 7.0 percent in December, driven by a sharp jump in sales in the West.  Nevertheless, the median sales price for existing homes fell to $174,700, with prices in the West 31.6 percent lower than in December 2007. The widespread decline in home prices, echoed by the 1.9 percent decline in the Case-Shiller 20-city home price index in November, is attributable not only to weak demand but also to distressed, heavily discounted sales of foreclosed or nearly-foreclosed homes.  While distressed sales help to reduce the backlog of unsold or vacant homes, there is no evidence that the housing market has reached its bottom.

The Fed leaves its target rate unchanged.  The Federal Open Market Committee’s (FOMC) target federal funds rate remained unchanged at 0 percent to ¼ percent and warned that the rate is unlikely to change for some time.  The Fed also announced that it will begin buying long-term Treasury debt and expand its exposure to private sector debt in efforts ease credit conditions for the mortgage market and commercial debt.  Inflationary pressure has lifted as commodity and energy prices have fallen sharply.  FOMC members warned that economic conditions, both domestically and internationally, have deteriorated significantly since their meeting in December.  Members did announce that financial markets have stabilized particularly for households and businesses, although credit remains extremely tight.