Projected Economic Expansion in 2025 and Beyond: Expansion Persisting with Persistent Inflation
The economic outlook for 2025 indicates growth, albeit at a slower pace compared to 2024. Inflation will continue to surge beyond the Federal Reserve's desired level, predominantly due to President-elect Trump's policies, which include an emphasis on spending while limiting production. The primary threat posed is not a potential recession but rather the constraint of production capacity as immigration levels dwindle.
The Shift in Economic Momentum for 2025
The American economy has experienced notable growth throughout 2024. The latter half of the year saw expansion at a faster pace than the average, as evidenced by the Atlanta Federal Reserve's GDPNow estimate for the fourth quarter. Employment has been steadily rising across all twelve months of the year, with the exception of the final data for December 2024.
Consumer expenditure registered a substantial increase, climbing by nearly 4% over the previous 12 months after adjusting for inflation. Employment levels are at an all-time high, and wages are now increasing at a faster pace than inflation. Although consumer borrowing is not on an exponential growth trajectory, households have amassed substantial savings due to the stimulus checks distributed during the pandemic. This sector will undoubtedly be a strong contributor to the economy in 2025.
The construction sector has remained relatively stagnant, with the surge in data center and semiconductor fabrication plants offsetting decline in residential and commercial building. Business capital spending has also seen a drop, except for those related to data centers and semiconductor fabrication.
Government expenditure continues to rise at both federal, state, and local levels, with some of the growth at the state and local levels attributable to federal grants.
U.S. exports have remained stable over the past year, while imports have increased. The strong dollar has see U.S.-manufactured products becoming more expensive for foreign buyers, while imported goods become more affordable for American consumers and businesses.
The Fed believes that interest rates are somewhat restrictive, as they are currently higher than the neutral rate of interest, which is not observable. The increase in interest rates from 2021 has undoubtedly had a negative impact on construction and possibly business capital spending as well.
Discussing the various factors together, the U.S. economy is entering the new year with a promising overall momentum, despite some sectors showing limited strength.
2025 Economic Prospects
Labor force supply will be the most significant barrier to economic growth in 2025. With the strong momentum as we enter this new year and the persistence of federal government spending, overall spending should be more than sufficient to keep the economy at its full capacity.
Instead of approaching the forecast adopting a Keynesian perspective—focusing on how much spending will intensify—we should consider the 2025 growth through a supply-side viewpoint: how much can the U.S. economy produce?
Productivity (output per person) changes gradually, meaning that in the short-term, labor force supply will be the primary determinant of inflation-adjusted production. Any excess spending will merely push inflation higher.
Immigration has played a considerable role in promoting job growth over the past two years, but President Trump is expected to curb border crossings shortly after his inauguration. This will inevitably lead to a decrease in economic growth rates. The economy will continue to expand, albeit at a slower pace than the past two years, thanks to some immigration and productivity progress. A recession is unlikely, but the rate of growth will undoubtedly be less than it has been. GDP adjusted for inflation grew by 2.7% in the last four quarters of 2024. By the end of 2025, this figure will have fallen to 2.1%, and by the end of 2026, it will have dropped further to 1.6%. Although the slowdown will not constitute a recession, it will translate into a weaker pace of growth.
Most businesses will not notice the difference between the current and upcoming growth rates, but those small changes will be significantly outweighed by individual firms' demand and supply fluctuations. Firms planning to expand to capitalize on growth may find themselves incurring costs without corresponding revenue.
Inflation is unlikely to decline significantly in this environment. The Fed had hoped to reach their target of 2% inflation, but that goal was not met in 2024, and it possibly won't be achieved in 2025. This predicament stems from an oversupply of money in the economy when it comes to goods and services.
The Fed may reduce short-term interest rates twice, as they are currently anticipating, provided they observe some improvement in inflation first. If the Fed takes a minimalist interpretation of inflation, they will argue that they have made progress towards their objective.
Tariffs will introduce complications for Federal Reserve policy. Most economists believe that tariffs lead to a temporary increase in the price level but do not trigger an ongoing increase in the inflation rate. Fed chair Jerome Powell mentioned that research done in 2018 has found that if tariffs trigger a one-time increase in prices, the Fed would essentially disregard these price increases while evaluating inflation and adjusting policy accordingly. This approach represents the Fed's most probable response to tariff increases. If tariffs and retaliatory tariffs impact the domestic economy negatively, the Fed might cut interest rates to support the economy rather than raise them to combat inflation. It could be argued that tariffs and retaliatory tariffs mimic supply chain problems, which produce only inflation, but the Fed's modeling from 2018 suggests otherwise.
In conclusion, the most probable trajectory for interest rates in 2025 is unlikely to change, with a slight possibility of a quarter-point cut or two.
Overseas disputes pose a substantial danger to the U.S. financial system. Although major alterations are unlikely, the global economy generally appears stable. According to the FocusEconomics predictions for 2025 and 2026, global overall GDP is projected to grow at a consistent rate. (FocusEconomics gathers opinions from economists specializing in numerous countries; averages their forecasts for each country; then summarizes them for global or regional expectations. Given the impossibility of monitoring every significant country, this methodology is likely most suitable for a global forecast.)
Potential conflicts could disrupt economic forecasts, as the Russia-Ukraine conflict demonstrated. China-Taiwan could potentially ignite. Moreover, the Middle East continues to be a hotbed of disturbances.
Locally, tariffs and retaliation could plunge the American economy into turmoil. Supply chains differ, but many are rigid rather than adaptable. Common items such as wheat, oil, or copper can easily be procured from different nations if tariffs raise prices from one supplier. On the other hand, customized goods pose a major challenge. For example, if an automobile manufacturer contracts with a supplier for a specific style of component for a specific car model, switching suppliers would be challenging. Many internationally traded goods fall between these two extremes.
Though a trade war wouldn't plunge the global economy into a recession, it could certainly halt growth, with the most severely affected industries actually entering a recession.
Decreased immigration is anticipated and factored into the projection provided above, but widespread deportations could trigger a recession. Numerous economic activities depend on laborers without or questionable work permits. Sudden loss of a substantial fraction of this labor force would result in construction, agriculture/food processing, and leisure/hospitality sector production declines. The economy could recover, but adjusting from a sudden change would be highly detrimental in the short term.
Significant electrical interruptions pose a risk to numerous enterprises. The country's electrical grids have become less resilient. The root causes could originate from weather, mechanical failures, or natural disasters. A robust grid keeps issues contained, but a weak grid propagates outages across a vast area. While we're not in Cuba's dire straits, we have closed down aged, reliable fossil-fueled power plants before dependable alternatives are fully established. The most damage would be regional, with specific threats for the most energy-intensive industries.
On the positive side, artificial intelligence could enhance output per worker in various sectors, such as healthcare, finance, manufacturing, and information technology. This would lead to higher inflation-adjusted GDP, despite limited labor force growth. However, the upside potential is not as significant as the downside possibility.
Given this perspective, businesses should allocate limited resources to contingency planning for alternative economic forecasts and invest more in industry-specific supply risks. These risks could stem from new policies related to tariffs and immigration as well as supply chain issues.
- The anticipated economic forecast for 2025, influenced by President-elect Trump's policies, includes a focus on spending and limited production, which could contribute to inflation surpassing the Federal Reserve's desired level.
- To maintain economic growth in 2025, despite the expected decrease in immigration under President Trump's policies, businesses might need to adjust their expansion plans, as the slowdown in growth will not result in a recession but will translate into a weaker pace compared to the past two years.
- Tariffs, introduced as a part of President Trump's policies, could create complications for Federal Reserve policy, potentially leading to interest rate cuts to support the economy rather than raises to combat inflation.
