OECD Economic Outlook, Volume 2025 Issue 2

United States

Real GDP growth is projected to slow to 2% in 2025 and 1.7% in 2026 before picking up to 1.9% in 2027. This slowing results from continued cooling in employment growth, the sharp slowdown in net immigration, the pass-through of tariff increases to the price level and large cuts to non-defence discretionary spending. As tariff effects dissipate, disinflation resumes and reductions in the federal work force conclude, growth is projected to recover towards potential. A key downside risk to the projection is a correction to equity markets that have been buoyed by the hopes of high returns to investment in AI, although new advances in AI could boost growth in the years ahead.

With downside risks to the labour market having increased and underlying inflation pressures appearing manageable, some further monetary policy easing in 2026 appears warranted. Fiscal policy is on an unsustainable trajectory, with large structural deficits and a high and rising debt-to-GDP ratio. A significant adjustment will be required over several years. Regulatory and institutional reforms should focus on boosting housing supply and infrastructure, as well as addressing labour shortages.

Activity has been resilient despite cooling job growth and stubborn inflation

Job growth has cooled considerably this year. However, there has not been an appreciable increase in the unemployment rate, as the sharp reduction in net immigration since 2024 has yielded markedly slower labour force growth. On the demand side, the vacancy rate has continued to edge down and is back to normal levels. Meanwhile, hiring and quit rates are at their lowest levels in over a decade. Despite rapidly cooling job growth and numerous headwinds, real GDP growth through the first half of 2025, at 1.1% (annualised), was fairly resilient, if uneven. Excluding AI-related investments, which continued to boom, GDP contracted by 0.1%. Household consumption growth moderated over the period, while government purchases began to contract after a long period of expansion. Non-AI-related investment weakened. Indicators of economic activity through August, including retail sales and personal income, suggest more robust growth in recent months that has been less reliant on AI investment. Headline inflation, already above the Federal Open Market Committee’s (FOMC) 2% target, has edged up since tariff increases began to take effect. A measure of inflation that excludes volatile food and energy prices, as well as housing costs—thus providing a better indicator of underlying inflation pressures‑-exhibits a similar pattern. However, wage pressures appear muted and longer-term inflation expectations remain well-anchored. The 12-month change in average hourly earnings stood at 3.8% through September, down from 4% at end-2024. The 10-year breakeven inflation rate, at 2.2%, is just a little above its historical average during expansions.

The significant shift in US trade policy since the beginning of 2025 has led to an unprecedented increase, from 2.5% to 14.0%, in the legislated effective tariff rate on imports. But the full impact of the tariff increases on the US economy has likely not yet been felt, as the observed tariff rate, as calculated by customs duties as a share of import values, was 10.1% through August. Nevertheless, the tariff increases are affecting trade. In early 2025, import volumes surged as firms front-loaded shipments ahead of the newly announced tariff increases. Since tariffs went into effect, import values on tariffed goods have fallen significantly relative to non-tariffed goods.

United States 1

1. Real GDP growth ex. AI covers real GDP growth excluding information processing equipment and software investment.

Source: Bureau of Labor Statistics; and Bureau of Economic Analysis.

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United States: Demand, output and prices

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United States 2

1. Personal Consumption Expenditures Excluding Food, Energy, and Housing (Chain-type Price Index).

2. Cyclically Adjusted Price Earnings Ratio (CAPE, P/E10).

3. The Cleveland Fed estimates the real interest rate using a statistical model that jointly extracts signals from Treasury yields, inflation data, inflation expectations, and survey forecasts. This model decomposes observed interest rates into expected inflation, term premiums, and the underlying real rate of interest.

Source: Bureau of Economic Analysis; shillerdata.com; and Federal Reserve Bank of Cleveland.

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Monetary policy easing will support activity, while budget deficits will remain large

With the labour market showing signs of stalling and the pass-through of tariff increases to prices relatively muted to date, the Federal Reserve resumed monetary policy easing at its September and October meetings with 25-basis point cuts to the federal funds rate target range, which now stands at 3.75‑4%. A gradual easing to a terminal target range of 3.25-3.5% by end-2026 is anticipated provided the labour market does not weaken further or underlying inflation pressures do not materially worsen.

The budget deficit on a general government basis is set to narrow a little in 2025, though at 7.5% it remains very large—especially for an economy that has been operating at or above potential. The deficit is expected to remain roughly the same size over 2026 and 2027, as new tariff revenues and cuts to non‑defence discretionary spending are roughly offset by the net deficit-expanding measures associated with the One Big Beautiful Bill Act (OBBBA) and lower revenues from weaker economic growth. With Congress unable to reach agreement on discretionary appropriations for fiscal year 2026, a partial shutdown of the US federal government began on 1 October, the first day of the fiscal year. As a result, for 43 days roughly one-third of the federal workforce was furloughed, and most federal employees did not receive pay during that period.

Real GDP growth will fall below potential yet progress on disinflation will be slow

Robust GDP growth in recent years has been underpinned by strong household consumption and an above-average contribution from government purchases. Household consumption growth is projected to slow as cooling job growth and the further pass-through of tariff increases to prices dent growth in real disposable personal income. Government purchases are projected to contribute little to growth on average through 2027 largely because of the Administration’s efforts to reduce non-discretionary defence spending. However, business fixed investment is expected to benefit from continued strong AI‑related investment and a boost from new and enhanced business investment incentives in the OBBBA. Inflation is expected to rise further through mid-2026 as the direct effects of tariff increases on import prices and spillover effects to domestically produced goods and services boost the price level. As these effects fade, headline inflation is expected to return roughly to target by end-2027.

Risks to the baseline GDP growth projection are tilted to the downside. With the cyclically-adjusted price-earnings ratio for the S&P 500 near an all-time high, the risk of a sharp correction in equity markets is high. A tightening of credit or liquidity stress in the shadow banking sector would constrain credit supply to households and firms. The labour market could be weaker than anticipated. Inflation may be more persistent than assumed, which would lower real incomes and reduce scope for lower interest rates. On the upside, a continued surge in investment in the tech sector, new advances in AI or a boost to on-shored manufacturing could provide further impetus to GDP growth. Household consumption could prove more resilient than projected, especially if the share of tariff increases passed on to the final consumer is lower than expected.

Policy priorities include unlocking supply and maintaining vital services

Monetary policy needs to strike a delicate balance between responding to the softening of labour market conditions and addressing persistent above-target inflation, but further easing is warranted as long as inflation is judged to remain on track to return to target. Reducing the very large fiscal deficit and stabilising the debt ratio should be a priority. Cuts to federal spending and the federal workforce should be well-targeted and not threaten the delivery of vital government services and research programmes. The United States faces a structural economic problem of constrained supply, driven by regulatory and institutional bottlenecks that hinder growth in key sectors such as housing and infrastructure. Labour shortages in critical industries are also a concern. To unlock supply in housing, local zoning laws should be reformed to allow for higher-density, multifamily housing development in urban areas. Streamlining of permitting reviews can boost infrastructure investment. To better align demand with supply for labour in critical industries, the system for temporary and permanent employment-based visas requires a redesign.