The Economy
2025 Outlook: Does Anyone Really Know Anything?
January 2025
Okay, sure, there are no doubt lots of people who know lots about lots of stuff. But, when it comes to making a detailed forecast of the path of the U.S. economy in 2025, “nobody knows anything” seems a more appropriate theme. After all, even if the broad contours of changes in fiscal, regulatory, trade, and immigration policy to be seen over coming months are taking shape, the range of potential outcomes around the specific details in each of those areas is so wide that it is hard to have much, if any, confidence in any economic forecast for 2025 made before those details emerge. This being our January edition, however, we are bound, we’re pretty sure by law, to offer an outlook for the economy in the year ahead. To that end, we’ll offer a brief summary of our 2025 forecast, based on the current policy mix, and, along the way, report on how some of our 2024 forecasts fared. Our January 2025 baseline forecast, however, may be better seen as a point of reference as to how we’ll see the impacts of policy changes as the details of those changes emerge in the months ahead. We’ll also discuss some of the key factors we think will more fully shape the path of the U.S. economy in 2025.
As in 2023, real GDP growth surprised us to the upside in 2024, and for the same reasons. The combination of rapid growth in the supply of and productivity of labor allowed for above-trend real GDP growth while allowing for further deceleration in inflation, though progress on that front stalled as 2024 came to a close. Though the Q4 data are not yet available, full-year 2024 real GDP growth was tracking at 2.8 percent, handily beating our forecast of 2.1 percent growth, and even further outpacing the Blue Chip consensus forecast of 1.6 percent growth. We do not, however, expect another year of above-trend growth in 2025; our baseline forecast anticipates real GDP growth of 2.2 percent in 2025, with a marked slowdown in labor supply growth and a “higher for longer” interest rate profile weighing on growth.
While the pace of job growth slowed as we anticipated in 2024, the labor force grew faster than we anticipated, putting upward pressure on the unemployment rate. For full-year 2024, the unemployment rate averaged 4.0 percent, just above our forecast of 3.9 percent. While we expect job growth to slow further in 2025, we expect slower labor supply growth to blunt upward pressure on the unemployment rate, which we expect to average 4.1 percent for full-year 2025. Despite slowing job growth, aggregate labor earnings – the largest block of personal income – continue to grow at a rate faster than inflation, which has been a support for consumer spending. We expect growth in consumer spending to realign with growth in after-tax income in 2025 after what has been a wide gap over the past few years.
While we expected headline and core inflation as measured by the PCE Deflator to remain above the FOMC’s 2.0 percent target through 2024, we also expected a more pronounced slowdown than proved to be the case, as inflation began to reaccelerate over the final months of 2024. Our January baseline forecast has both headline and core PCE inflation averaging 2.4 percent for full-year 2025. Though not precluding further cuts in the Fed funds rate, particularly with many FOMC members nervously eyeing softer labor market conditions, that inflation is proving to be so persistent does limit the scope for further funds rate cuts. After 100 basis points of cuts to the Fed funds rate in 2024, as our forecast anticipated, we anticipate two twenty-five basis point cuts in 2025. Even should that prove to be the case, it may bring little relief from elevated long-term interest rates, as concerns over persistent inflation and the gaping federal government budget deficits figure to put a floor under yields on longer-term U.S. Treasury securities. To the extent that mortgage interest rates are influenced by yields on 10-year U.S. Treasury notes, this does not bode well for the housing market in 2025, and we expect starts and sales of new single family homes to be lower than in 2024.
As we discussed last month, potential changes to immigration and trade policy are sources of uncertainty around the 2025 outlook. We think it important to note that subsequent to last month’s edition the U.S. Census Bureau released their latest estimates of U.S. population. The updated data incorporate revised methodology for estimating international migration, which we and others have argued Census was significantly undercounting over recent years. Indeed, the latest estimates show far greater international in-migration since 2022 than had previously been estimated, which the Census data now show to have accounted for roughly eighty-five percent of total U.S. population growth from 2022 through 2024. This highlights the extent to which foreign born labor has been the catalyst for the faster growth in the supply of labor over this span, but also highlights the potential for there to be an adverse labor supply shock – resulting in growth being lower and inflation being higher than our baseline forecast anticipates – should there be a significant slowdown in the inflow of foreign born labor. Indeed, by year-end 2024, there were already signs of such a slowdown, and this is clearly something to monitor in the months ahead.
As we see it, the potential effects on wages, output, and inflation stemming from changes to immigration policy would be felt much more acutely, and more immediately, than the effects of expanded tariffs. After all, between timing, exemptions, workarounds, and fluctuating currency values, there are several factors which could blunt the inflationary impact of expanded tariffs, but there would be no offsets for an adverse labor supply shock. That said, to the extent expanded tariffs do push up prices of imported consumer goods, that would exacerbate the financial stress stemming from the cumulative increases in prices over the past few years already being felt amongst many lower-to-middle income households.
In terms of consumer spending, there is already a clear divide across income/wealth lines. Many lower-to-middle income households, far less likely to have reaped the benefits of rising asset prices over recent years, have sharply curtailed discretionary spending, while higher-income households and/or those having seen significant increases in net worth continue to engage in such spending. A sharp correction in equity prices and/or a meaningful decline in house prices, however, could easily trigger negative wealth effects which, in turn, would curb discretionary spending. At the same time, to the extent interest rates remain elevated, spending on consumer durable goods will be impaired while those households with variable rate debt obligations, including credit card debt, will get little, if any, relief from debt service burdens. These factors all pose downside risks to our forecast for growth in consumer spending in 2025.
Perhaps one of the most underappreciated stories of the recent past is the marked acceleration in labor productivity growth, which averaged 2.4 percent over the eight quarters ending with Q3 2024. Whether, or to what extent, this can be sustained is another key question in 2025. The rate at which any economy can grow on a sustained basis over time without sparking inflation pressures is a function of the rates of growth of total labor input and labor productivity. Productivity growth not only allows for wages to grow over time without impinging on profit margins or igniting inflation pressures, but is also the ally of firms facing labor supply constraints. If we are correct in expecting much slower labor supply growth 2025 than has been the case over recent years, sustaining the recent acceleration in productivity growth will be critical in supporting real GDP growth and tamping down inflation pressures.
Though the U.S. economy ended 2024 on firm footing, there is considerable uncertainty looming over the outlook for the year ahead. As such, it seems fitting to wrap our 2025 outlook by repeating a call we clearly got right in both our 2023 and 2024 outlooks, which is that at the end of the year, the economy is unlikely to look as we, at the start of the year, expect it to, even if we do not now know why that will be the case.
Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; U.S. Census Bureau.
As of January 16, 2025
