Despite rising interest rates, recession in other major countries, and the depletion of surplus reserves, the US economy continues to grow faster than expected. Although real GDP growth slowed in the first quarter of this year, officials appear to have avoided a recession while lowering inflation closer to the 2% objective.
Scenario Consumer price index (CPI) inflation remains above 3% in the second quarter of this year, before declining to 2.7% by the end of 2024.
The Federal Reserve successfully walks the tightrope to a smooth landing by reducing interest rates twice in the second half of 2024 and continuing to do so until it reaches the neutral range of 2.5% to 3% in 2027. Job growth is slowing because current levels of job creation are unsustainable, given demographics and labor force participation. As a result, the unemployment rate reduces in the short term, then climbs to just under 4% in 2025 before progressively falling for the remainder of the projected period. The Inflation Reduction Act prompts major investments, which promote manufacturing.3 Furthermore, investments in intellectual property, such as the usage of AI and other cutting-edge technologies, will continue to fuel business growth. Overall, we predict the US economy to increase by 2.4% this year before slowing to 1.1% in 2025. Between 2026 and 2028, economic growth is predicted to resume, with annual real GDP improvements ranging from 1.6% to 1.9%. Persistent inflation and global conflict (20%): While our baseline remains positive, any prediction is subject to negative risk. We identify threats centered on three interrelated issues: 1) Geopolitical tensions, 2) Persistent inflation, and 3) Financial System Stress. Major confrontations in
Ukraine and the Middle East have been simmering for some time; one or both could escalate to a new level.
We believe that such escalation will most likely result in greater pricing for imported goods and oil. In this scenario, oil prices rise to roughly $100 for three quarters before gradually falling. Geopolitical wars are not fought solely with guns. Tariffs and sanctions have been utilized to varied degrees by the previous two American administrations to exert influence over adversaries. The employment of these tools may have an impact on the costs paid by American businesses and consumers. In this scenario, we simulate tariffs that raise the cost of imported intermediate inputs by 1% and imported finished items by an additional 1%. As a result of the tariffs and the oil price shock, the Federal Reserve is expected to raise interest rates twice in the short term. Even with this measure, CPI inflation remains above 3% through the second quarter of 2025. The recent Federal Reserve Financial Stability Report4 identifies three near-term vulnerabilities to the financial system's stability: higher-for-longer interest rates, escalating geopolitical turmoil and spillovers, and strains on real-estate markets, particularly office real estate. In accordance with the other assumptions indicated above, we predict an increase in financial system stress. GDP growth in this scenario is slower than in the baseline scenario, especially during the next two years. Growth in 2024 is 2.2%; by the following year, the tariffs have been fully applied, and growth in 2025 is only 0.6%.
Between 2026 and 2028, annual growth averages 1.7%.
A golden period in labor markets (10%): AI is today's fashionable buzzword, yet the increasing sophistication and availability of technology and software has already replaced certain occupations while generating others. This type of shift will continue—and, because technological change is not always linear, there is always the chance of rapid improvements that dramatically increase productivity. From 2024 to 2028, worker productivity increases by an average of 1.7% per year, compared to 1.4% in the baseline. In addition to the productivity dividend, population growth rises from an average of 1.8 million per year in the baseline to 1.9 million annually. As a result, the population will be 525,000 higher by 2028. Older workers will postpone retirement, resulting in higher labor force participation rates than the baseline. With a larger population base and a workforce that works longer hours, there will be more individuals looking for work—and if demand remains high, they will find it. Total employment levels will rise, with stronger growth in the forecast's outer years. In this scenario, GDP will grow faster than the baseline prediction for the whole forecast period. From 2024 to 2028, GDP will grow at an average annual rate of 2.2%, 0.5 percentage points more than the baseline prediction. This scenario also results in a larger long-term potential for the economy, at 2.3% against 1.7% in the baseline. In that respect, this scenario illustrates what it would take to continue recent rates of economic development in the long run.
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