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7 1 The U.S. Economic Outlook for 2025 Jeffrey M. Humphreys Terry College of Business, University of Georgia (Revised on December 5, 2024) The Terry College's 2025 baseline forecast for the US economy calls for slower economic growth. The lagged effects of the Federal Reserve's 2022 policy pivot from easy money to tight money is largely responsible for the slowdown. The slowdown in US GDP growth will be gradual. We predict US GDP will grow by 1.6 percent in 2025 compared to 2.5 percent in 2024. The slowdown in job growth while more pronounced that the slowdown in GDP growth will be gradual rather than steep. Indeed, our baseline forecast depends on job growth as well as the still strong financial position of households to sustain the post-pandemic economic expansion. In 2025, the Federal Reserve will further ease monetary policy with cuts in policy interest rates as well as the end of quantitative tightening. Barring an unexpected shock or policy mistake, the recent and continuing shift from tight money towards easy money should prevent economic growth from stalling, or declining. If our forecast for 1.6 percent US GDP growth bears out, then the pace of GDP growth will be below the economy's potential rate of growth – approximately 2 percent GDP growth, but well above the economy's stall speed – less than 1 percent GDP growth. The labor market will be strong enough to stave off a recession. The US economy will be vulnerable to something else going wrong, however. The short list of possibilities includes (1) federal policy mistakes, (2) monetary policy mistakes, (3) an energy-price shock, (4) a stock market crash, (5) another banking/financial crisis that is less well contained than the 2023 "mini-crisis", or (6) a broadening of military conflicts abroad. Several imbalances increase the risk of recession, including annual federal budget deficits that exceed 6 percent of GDP, overvalued housing and stock markets, many financial institutions own too many overpriced bonds, and many nonbank financial institutions have extended a lot of credit. We put the probability of a US recession beginning in 2025 at 25 percent, which is lower than the 40 percent risk we estimated at this time last year, but above the 15 percent average, or typical, annual recession risk. The lagged effects of Federal Reserve's aggressive tightening of monetary policy in 2022 and keeping policy interest rates at elevated levels through most of 2024 is the main reason we expect growth will slow in 2025. It is worth noting that the economic slowdown is not due to an economic shock. The policy pivot was successful in containing inflation without doing too much damage to the labor market and in turn to the overall US economy. Large increases in policy interest rates coupled with substantial reductions in the Federal Reserve's balance sheet – quantitative tightening – rapidly brought down the highest inflation rate in 40 years. Tight money gradually pushed up the unemployment rate just enough to dampen inflation without causing a recession, which an impressive achievement – the proverbial "soft landing." The main factors behind the recent surge in inflation include supply chain problems, energy price shocks, unprecedented federal fiscal stimulus, and the very rapid growth of the money supply. The money supply expanded by 25 percent and by 13 percent in 2020 and 2021, respectively. Over 2022-24, almost all the major supply chain problems were resolved, which helped to rein in inflation. Energy prices retreated from the highs experienced in the wake of Russia's invasion of Ukraine. Quantitative tightening reduced the money supply, which shrank by 1 percent and 2 percent in 2022 and 2023, respectively. In addition, demand-side drivers of inflation responded to higher interest rates. For example, housing quickly went into recession. Consumer and investment spending cooled. Federal fiscal stimulus to households ran its course. Put it all together and inflation dropped from 8.0 percent in 2022 to 4.1 percent in 2023 and to 3.0 percent in 2024. Although the inflation rate was cut by more than 60 percent, it did not drop to the extremely low levels experienced prior to the pandemic recession. That is because several drivers of inflation did not improve. For example, a retreat from globalization (e.g., tariffs) and less favorable demographics are here to stay.

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