U.S. outlook for 2025

R. Andrew Butters

Associate Professor of Business Economics and Public Policy, Blanche “Peg” Philpott Fellow, Kelley School of Business

Jennifer Rice

Senior Lecturer of Business Economics and Public Policy, Kelley School of Business

Brian A. Vander Schee

Clinical Associate Professor of Marketing, Kelley School of Business

When the Futurecast panel toured the state throughout November, we had data through the third quarter of the year. When we refer to the past year in what follows, we will mean the four quarters from 2023 Q4 through 2024 Q3. Our current outlook is for 2025, but it also includes the final quarter of 2024. Below, we divide these five forecast quarters between the first three (column two in Table 1) and the final two (column three).

The past year

We were subjectively optimistic on our forecast for 2024, despite the fact that there appeared to be several potential factors that could cause significant headwinds for the economy. These headwinds included, but were not limited to:

• a labor market that was not in balance (i.e., excess demand),

• monetary policy that was projected to be restrictive going forward,
• an unsustainable fiscal situation as it related to federal deficits and

• geopolitical risks abroad.

As it turns out, that optimism was well placed, and as we’ll highlight below, there could have been room for even more optimism.

A year ago, we thought that growth in real gross domestic product (GDP) was likely to run just below trend—which we projected to be near 2.0%—for most of 2024. As shown in Figure 1, actual growth in output (shown by the solid black line) has averaged 2.7% over the past four quarters—stronger than our forecast from last year (shown by the dashed gray line).

Figure 1: Quarterly U.S. real GDP growth

Note: This data is quarter-over-quarter growth at a compounded annual rate.
Source: U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDPC1, November 6, 2024, and authors’ calculations for the forecast

If one had to point to the primary source of the relative strength in the economy over the last four quarters, it would have to be the consumer. As shown in Figure 2, real personal consumption growth over the last four quarters (shown by the solid black line)—averaging 3.0%—has exceeded our expectations from last year (shown by the dashed gray line). This resilience of the consumer can at least partly be attributed to the strong balance sheet that many households developed from the savings coming out of the pandemic, and the relative stability of the labor market over the last year.

Figure 2: Quarterly U.S. real personal consumption growth

Note: This data is quarter-over-quarter growth at a compounded annual rate.
Source: U.S. Bureau of Economic Analysis, Real Personal Consumption Expenditures [PCEC96], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PCEC96, November 6, 2024, and authors’ calculations for the forecast

In fact, if there was one headwind we mentioned last year that turned out to be an upside in 2024, it would be the balance of the labor market. Many projected a significant weakening of the labor market—with a sizeable increase in the unemployment rate—would be required for needed progress on inflation to materialize. As shown in Figure 3, the unemployment rate did increase gradually over the last four quarters (shown by the solid black line), but has remained relatively low and is still below what many (us included) projected just a year ago.¹ The fact that significant progress on inflation has been made—the latest read of year-over-year core personal consumption expenditures (PCE) price index inflation is down to 2.7%—with only a small uptick in the unemployment rate bodes well for a “soft landing.”

Figure 3: Quarterly U.S. unemployment rate

Source: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNRATE, October 21, 2024, and authors’ calculations for the forecast

Moreover, despite only a modest uptick in the unemployment rate, the labor market is much more in balance now than it was four quarters ago. One common measure of the state of the labor market is the ratio of job openings to the number of unemployed persons in the economy. Figure 4 plots the recent time series of this ratio. This ratio is intuitively interpretable as the number of open jobs per individual looking for a job, and has been a common metric for economists to measure the relative demand/supply of the labor market.²

Figure 4: Quarterly U.S. job openings to unemployed persons ratio

Source: U.S. Bureau of Labor Statistics, Job Openings: Total Nonfarm [JTSJOL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/JTSJOL, October 21, 2024, and U.S. Bureau of Labor Statistics, Unemployment Level [UNEMPLOY], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UNEMPLOY, October 21, 2024

What’s immediately evident from this indicator is how unprecedented the excess demand for labor was coming out of the pandemic—with the ratio approaching two job openings per unemployed person. The recent experience, however, indicates a labor market much more in balance, with this ratio declining and approaching one job opening over the last couple of quarters. In principle, this ratio decline could have arisen by either an increase in the number of unemployed persons or a decrease in the number of job openings. Over the last four quarters, it has largely occurred due to the latter.

On net, it is the labor market over the last four quarters that has likely provided the foundation for the resilient consumer and a better-than-anticipated trajectory for the economy. In fact, the remaining headwinds we mentioned in last year’s forecast were quite prescient. The Federal Reserve did, in fact, maintain a restrictive “higher for longer” monetary policy stance for much of 2024, only just recently lowering rates. The situation surrounding federal deficits continues to look bleak and the geopolitical risks abroad appear only to have exacerbated since last year.

The next year

So, what do we forecast for 2025? Broadly speaking, we remain optimistic that the economy is reaching its equilibrium growth rate and that aggregate demand and supply are coming back into balance after what has been several years of imbalance arising from the pandemic.

To be more specific, as shown in row one of Table 1 and in Figure 1, during the final quarter of 2024 and the first two quarters of 2025, we expect that output growth will be 2.1% and remain at that level over the final two quarters of 2025. The low point over the forecast horizon is the first quarter of 2025, when we forecast growth to be 1.9%. Inflation, shown in row two of Table 1, continues to decline over our forecast horizon. As measured by the core personal consumption expenditures (PCE) price index—the preferred measure of the Federal Reserve—inflation should move from an average of 2.8% over the past year to just 2.2% in the second half of 2025.

The outlook for the labor market parallels that of growth, as shown in Figure 3 and the third and fourth rows of Table 1. We project a small decline in job growth—to an average monthly gain of 130,000—and a small uptick in the unemployment rate in the first half of 2025, but then we project that both will improve slightly in the second half of 2025.

Upside and downside risks to the forecasts

After three consecutive years of national outlooks heavily influenced by the course and recovery from the pandemic, this year’s outlook is noticeably more “typical.” This at least partly reflects that between growth, the labor market and inflation, we have entered considerably more “normal” ranges recently.

At this point, many of the shocks initiated by the pandemic have receded (e.g., supply chain challenges) or have become so entrenched in the economy that businesses and households are regularly factoring them into their decisions (e.g., working from home/hybrid-work arrangements). Significant progress has been made on inflation and the Federal Reserve has recommitted itself to both dimensions of its dual mandate (i.e., stable inflation and full employment). The Fed has initiated interest rate declines we expect to continue until a more neutral stance as it relates to monetary policy is achieved.

This begs the question: What could make our forecast incorrect over the next year? Here, it is important to acknowledge that two of the four headwinds we mentioned last year still pose significant potential risks to growth: (i) federal deficits and (ii) geopolitical risks abroad. While falling interest rates can reduce some of the pressures of the first, the increasing risks associated with the second are difficult to quantify, but that doesn’t make them any less relevant.

Two other factors that we will be tracking closely over the next year will be how the next administration handles trade policy and if the labor market continues to approach a balance. If progress on inflation stalls due to wars abroad or trade policy, a more volatile growth path could result. Moreover, if the demand and supply for labor gets out of balance again—perhaps due to a noticeable weakening of consumption leading to firms reducing payrolls—then even our “balanced” projection might be overly optimistic. However, it seems reasonable to expect a similar upside as was experienced this year. 

Conclusion

To sum up: Our economic outlook for the national economy during 2025 is fairly middle of the road and what could best be described as a “balanced-on-trend” growth path. We expect growth in output and employment to decrease slightly relative to its recent past. We also expect that inflation will continue to come down over the near term. In each of these cases, these projections would reflect an economy moving more toward its sustainable path of growth.