The fourth-quarter slowdown exposes how vulnerable late-cycle U.S. growth has become to fiscal disruptions, even as inflation’s persistence limits the Federal Reserve’s room to respond.
The U.S. economy decelerated more than expected in the fourth quarter of 2025, as a record-length federal government shutdown disrupted public spending, weighed on consumer and export activity, and exposed underlying fragilities in late-cycle growth.
At the same time, inflation remained well above the Federal Reserve’s 2% target, underscoring the policy tension facing central bankers entering 2026.
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According to the U.S. Department of Commerce, gross domestic product rose at an annualized 1.4% pace in the final quarter of the year, sharply below the 2.5% Dow Jones estimate and down from 4.4% growth in the third quarter. For all of 2025, the economy expanded 2.2%, compared with 2.8% in 2024.
Shutdown’s Direct and Indirect Costs
The Commerce Department estimated that the government shutdown, which ran from Oct. 1 to Nov. 12, shaved roughly one percentage point from fourth-quarter GDP, though it noted the precise effect “cannot be quantified.” Federal spending and investment dropped 16.6%, dragging overall government outlays down 5.1% for the quarter. State and local spending rose 2.4%, but not enough to offset the federal contraction.
The mechanical impact of lost government activity is only part of the story. Shutdowns also disrupt contractor payments, delay procurement cycles, dampen consumer sentiment among furloughed workers, and inject uncertainty into financial markets. These second-round effects often linger beyond the official end date.
President Donald Trump preemptively attributed the slowdown to the shutdown, writing on Truth Social that it cost “at least two points in GDP” and calling for lower interest rates. His comments again targeted Jerome Powell, chair of the Federal Reserve, whom he has repeatedly criticized over monetary policy.
Consumer and Trade Cooling
Personal consumption expenditures — the engine of U.S. growth — increased 2.4% in the quarter, down from 3.5% in the third quarter. The deceleration suggests that households began to moderate spending amid elevated borrowing costs and persistent price pressures.
Exports fell 0.9% after a 9.6% surge in Q3, reflecting softer global demand and normalization after earlier front-loading of shipments. Net trade, therefore, shifted from a strong contributor to a modest drag.
The inventory component was not highlighted as a major factor, suggesting that businesses are not aggressively rebuilding stockpiles. That indicates cautious corporate behavior rather than exuberant expansion.
Inflation Remains Broad-Based
While growth slowed, inflation data showed little sign of retreat.
The core personal consumption expenditures (PCE) price index — the Fed’s preferred inflation gauge — rose 3% year over year in December, up from November and still well above the central bank’s 2% objective. Headline PCE increased 2.9%. On a monthly basis, both core and headline measures rose 0.4%, exceeding expectations.
Crucially, price pressures were broad-based: goods rose 0.4% and services 0.3%. That distribution suggests inflation is not confined to a narrow category such as energy or tariff-sensitive imports, but remains embedded across sectors.
For policymakers, that breadth complicates the disinflation narrative. Services inflation, often tied to wages and domestic demand, tends to be more persistent. If service costs remain firm, the path back to 2% could be prolonged.
Underlying Demand Still Holding
Despite the weak headline GDP figure, underlying private-sector demand showed resilience. Final sales to private domestic purchasers — a measure that excludes volatile trade and government components — increased 2.4%. Though slightly below the prior quarter’s pace, it signals that household and business demand did not collapse.
Gross private domestic investment rose 3.8% after being flat in Q3, indicating that corporate capital expenditure remains intact. That strength may reflect continued spending on automation, digital infrastructure, and artificial intelligence technologies, areas that have supported productivity gains.
Heather Long of Navy Federal Credit Union described the shutdown’s impact as harmful but characterized the broader economy as resilient, citing solid consumption and AI-driven momentum.
Monetary Policy Crosscurrents
The Fed cut its benchmark interest rate by 75 basis points in late 2025 but has since shifted to a more cautious stance. Officials are navigating a narrowing corridor: growth is slowing, yet inflation remains elevated.
If the fourth-quarter weakness proves transitory and growth rebounds as federal operations normalize, the Fed may maintain a holding pattern. However, should consumption weaken further while inflation remains stuck near 3%, policymakers could confront a stagflation-lite environment — cooling output alongside sticky prices.
Financial markets will scrutinize labor data and early 2026 spending trends for confirmation of either scenario.
Fiscal Fragility and Political Risk
The episode underscores how political disruptions can reverberate through a $31.5 trillion economy. Even in an expansion supported by private demand, a federal shutdown can quickly dent output.
Repeated shutdown threats also risk eroding business confidence and raising risk premiums in financial markets. Investors price not only economic fundamentals but also governance stability. Persistent fiscal brinkmanship could introduce structural drag beyond any single quarter’s arithmetic subtraction.
2026 Outlook: Rebound Likely, But Not Guaranteed
Economists widely anticipate a bounce-back in early 2026 as deferred federal spending resumes and pent-up activity flows back into the system. The question is magnitude. A technical rebound could lift first-quarter growth, but underlying trends will depend on consumer resilience, labor market stability, and inflation dynamics.
If inflation eases gradually and investment momentum continues, growth could stabilize near its long-run potential rate. If inflation proves entrenched and rate cuts remain constrained, momentum may fade more meaningfully.