“An economic recovery has begun.”

-- President Obama’s remarks on the condition of the U.S. economy in his second inaugural address.

The new normal for the U.S. economy – sluggish growth – gave way to something more dire in the final three months of 2012.

Economic output actually shrank in the fourth quarter of the year. And while economists say that there are hopeful signs, especially higher consumer spending, and logical reasons for the contraction, pared down defense spending and Hurricane Sandy, having the first recessionary quarter since 2009 is still dire news.

Put it this way: If lawmakers had known how bad the economy was in December it would have been much harder for the president to have had his way on a suite of tax increases included in the “fiscal cliff” deal.

The argument than, and reiterated in Obama’s inaugural address, was that with a slow but steady recovery underway it was time for the federal government to undertake new domestic programs to address income inequality, global warming and other concerns.

But with those taxes in place, including an across-the-board hike on workers with the expiration of Obama’s payroll tax holiday and a sharp increase on income taxes on top earners, some in the financial world worry that the economy is just not strong enough to bear the burden of the Obama tax hikes.

Deepening their concerns is the fact that reduced spending by Defense contractors ahead of looming cuts was such a big part of the plan. The deal reached on taxes between Obama and Senate Minority Leader Mitch McConnell didn’t address the pending cuts, nor does a stopgap plan from House Republicans to temporarily extend the government’s credit limit.

So that leaves us with the taxes in place and little political agreement on what to do about the spending cuts that all agree will be harsh.

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Flush with victory, the president and his Democratic allies have laid out an ambitious agenda. On the economy, they want higher taxes and more spending in order to deal with income inequality and provide subsidies and federal programs for middle-class voters. And then there’s the rest: global warming, gay marriage, gun control, amnesty for illegal immigrants, etc.

It was always a long shot that Team Obama could achieve their loftiest goals. The next two years look to be mostly given over to continued fiscal fighting. Spending, taxes, the automatic cuts, borrowing, deficits and the rest consume so much time and energy that other big things would be hard to do. And because of various cliffs and deadlines, those issues are unavoidable.

But today’s economic report throws a pail of cold water on the Democratic embers of hope for a progressive agenda.

Bad economic news begets bad economic news and with the taxes and cuts already out there and Washington more bereft of agreement on big economic and fiscal issues than before the election, the bears will be growling.

If the president wants to hold the line for tax increases, higher spending and unconditional increases to the debt ceiling, he will be doing it over the increased objections of his Wall Street allies.

Similarly, House Republicans will pay a higher price for fiscal implacability with their Wall Street allies.

The central assumption of second-term Obamism is that the recovery is underway and requires more government intervention to begin to grow more robustly.

In fact, pro-stimulus liberals will argue that the shrinking economy should argue for more deficit spending.

But lawmakers, including many Democrats, are in no mood for deficit-funded stimulus spending these days. Debt anxiety among voters is high and getting higher.

So with the two parties at impasse over what to do about the crummy economy, the stakes will be higher than ever when the fiscal fights continue.

Given all that, the rest of the president’s domestic agenda looks like another victim of downsizing.

And Now, A Word From Charles

“Politically, [President Obama’s inclusion of same-sex couples in his immigration plan] is an act of sabotage. I think the way to deal with it is the way Schumer did, which is he agreed he wouldn't raise it. And I think the logical way to go about it is to have this as a separate provision, let the House and the Senate decide on this and leave it as a separate vote, and have the rest of the bill, however it emerges, as also a separate decision, because if you put them together you create a poison pill.”

-- Charles Krauthammer on “Special Report with Bret Baier.”

Chris Stirewalt is digital politics editor for Fox News, and his POWER PLAY column appears Monday-Friday on FoxNews.com. Catch Chris Live online daily at 11:30amET at http:live.foxnews.com.