By Annys Shin and Howard Schneider

Washington Post Staff Writers

Friday, January 30, 2009; 11:06 AM

Households and businesses slashed spending during the last three months of 2008, causing the quickest economic contraction in a quarter-century and deepening a recession entering its second year.

New data from the Commerce Department released this morning show the U.S. economy shrank at a 3.8 percent seasonally adjusted annual rate from October through December, compared with the previous three months. The number is an initial estimate that might change as more information is collected.

It was the steepest quarterly contraction since early 1982 -- when the country was mired in a deep downturn -- and shows how a global credit crunch, a weak U.S. real estate market and a decline in consumer spending have combined to undercut economic growth.

The 3.8 percent decline in gross domestic product from October through December compares with a 0.5 percent decline in the previous three months, and modest growth for the first half of the year. For all of 2008, gross domestic product -- a broad measure of the goods and services produced by the economy -- rose 1.3 percent, compared with 2 percent the year before. It is the weakest showing since 2001, when the aftershock of the collapse of the technology industry and the Sept. 11 terrorist attacks held annual growth to just 0.8 percent.

Although the economy did expand in 2008, economists believe the country slid into recession in December 2007, as growth slowed and businesses began cutting jobs.

This morning's data follow a wave of negative statistics from key global economies: plummeting December home sales in the United States, thousands of new U.S. job cuts, a nearly 10 percent decline announced today in Japanese industrial production.

Although the GDP report was better overall than expected -- many analysts were looking for a contraction in excess of 5 percent -- the details reflected broad weakness in the economy and led to predictions of more bad news to come.

Ian Shepherdson, chief U.S. economist with the High Frequency Economics consulting firm, noted that a large buildup in business inventories made the contraction seem more moderate than it was. Increases in private inventories are considered to add to economic growth. Factoring that out, the economy contracted by 5.1 percent over the quarter.

Other signs of weakness in today's report: Consumption spending fell 3.5 percent; exports dropped nearly 20 percent; and overall investment fell nearly 20 percent, with business purchases of equipment and software declining even further, by almost 28 percent.

"We are not comforted," said Shepherdson, because the details of the report show such weakness in main components of the economy.

President Obama is pushing a major stimulus package he says will help the country through the downturn, and the White House said that today's numbers emphasize the need for fast action. The House approved the package earlier this week.

The decline in GPD "is not just an economic concept, it is a continuing disaster for America's working families," Obama said this morning. "The recession is deepening and the urgency of our economic crisis is growing." "The large decline confirms the evidence from other indicators, such as payroll employment and the unemployment rate, that the U.S. economy continues to contract severely," Christina D. Romer, head of the Council of Economic Advisors, said in a statement. "Aggressive, well-designed fiscal stimulus is critical to reversing this severe decline and putting the economy on the road to recovery and improved long-run growth."

Stocks, which had stumbled yesterday on the dire economic data, opened up slightly today on the better-than-expected GDP report but quickly fell. The major U.S. indexes were all down about 1 percent at 10:47 a.m.

The slowdown has had a major impact on home sales, according to government data released yesterday. Sales of new homes in December plunged 14 percent from the month before and nearly 45 percent from December 2007, according to the government report. It was the worst month on record dating to the early 1960s.

Recent data have been even gloomier than many analysts' estimates. Home sales, for instance, were expected to fall to an annual pace of 397,000; instead they dropped to 331,000. Layoffs, too, have piled up faster than expected, worsening the outlook for an economic recovery.

Contributing to yesterday's job cuts was Eastman Kodak, the photography company based in Rochester, N.Y., which said it plans to cut up to 4,500 jobs, a fifth of its workforce. Kansas airplane company Cessna said it would let go of 4,000 workers, while Oshkosh, a Wisconsin maker of fire engines and dump trucks, said it would lay off about 1,000. British drugmaker AstraZeneca announced it would eliminate 6,000 jobs, including an undisclosed number in the United States, bringing its planned layoffs over the next five years to 15,000.

"Everybody, established corporations are pulling in the horns and trying to weather the storm," said John Ryding, chief economist for RDQ Economics, a research firm in New York.

Job cuts have swelled the ranks of those receiving unemployment benefits. Yesterday, the Labor Department announced that the number of people continuing to claim unemployment insurance had jumped more than expected, reaching 4.8 million for the week ending Jan. 17, the highest level since record-keeping began in 1967. As a percentage of the labor force, jobless claims fall short of the peak reached in the recession of the early 1980s.

Corporate layoffs are mounting as businesses scale back production in response to a drop in consumer spending. Orders for durable goods, big-ticket items such as washing machines and autos, decreased 2.6 percent in December, the fifth consecutive monthly decline, according to data released yesterday. Excluding defense purchases, the decline was 4.9 percent.

Businesses have little reason to resume their previous pace of production and won't for some time to come, Wachovia economist Tim Quinlan said. With fewer orders coming in, business inventories have grown 17 of the past 18 months. Goods are piling up at every step of the distribution chain, from manufacturing plants to retail stores. Quinlan said he doesn't expect business spending to rebound until the second half of 2010.

Ford reported a $14.6 billion loss in 2008, the automaker's worst annual performance in its history. Manufacturing conglomerate 3M is preparing for the worst. Yesterday, after reporting a 37 percent drop in fourth-quarter profit, the Maplewood, Minn., company said it would cut capital spending by 30 percent and conserve cash. The announcement came just weeks after the firm, which makes Scotch tape and Post-It Notes, said it would lay off 1,800 worldwide, put off merit pay raises and alter its vacation policies -- all moves that 3M estimates will save it more than $400 million over the next several years.

"The fourth quarter . . . was different from any pattern we've ever seen before, the synchronization of the world's economy in simultaneous contraction," chief executive George Buckley told analysts yesterday on a conference call. "Weak business conditions for consumer confidence and psychological fear factor made it worse."

The job cuts at Cessna are in addition to 2,200 announced earlier by Textron, its parent company. Textron said yesterday it plans to reduce capital spending by 42 percent and close its commercial finance business to help improve its cash position.

AstraZeneca spokesman Raymond Parisi said the additional job cuts announced yesterday are part of a restructuring effort that began in 2007. More than half of the 15,000 planned job cuts have already occurred. The money the company will save as a result of the layoffs will enable it to invest in other areas, Parisi said.

"The growth rate is not as high as its been," he said. "Basically, we're making sure we're fit for what we need to do to deliver on our commitments."

As recently as November, some experts were predicting the economy would contract by 2.5 percent on an annualized basis in the fourth quarter, after falling by 0.5 percent in the third quarter.

But that was before the global slowdown diminished demand for U.S. exports, hundreds of thousands more workers lost their jobs and penny-pinching consumers ruined Christmas for retailers. Economic conditions deteriorated in all 50 states in December, according to a report released yesterday by the Federal Reserve Bank of Philadelphia.

Many analysts now think the economy will not improve until later this year, provided a government stimulus plan kicks in. The best many are hoping for is that things don't get much worse.

"In September and October, the pace of downward adjustment intensified through the end of the year. We're going through the most intense phase," said Alan Levenson, economist for T. Rowe Price in Baltimore. "The rate of change is about as negative as it is going to get."