What Is the Ideal GDP Growth Rate?

How Fast Should the Economy Grow?

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The healthy GDP growth rate is one that is sustainable so that the economy stays in the expansion phase of the business cycle as long as possible. GDP is the nation's gross domestic product. That's the entire economic output for the past year. The GDP growth rate is how much more the economy produced than in the previous quarter. The ideal rate is between 2-3 percent. 

In a healthy economy, unemployment, and inflation are in balance. The natural rate of unemployment will be between 4.7 percent and 5.8 percent. The target inflation rate will be 2.0 percent. 

You'd think the more growth, the better. But a healthy GDP growth rate is like a body temperature of 98.6 degrees. Obviously, if your temperature is lower than the ideal, you know you're sick. If it's too low, you're near death. But a higher temperature can also mean you're sick. If it's over 100, you have a fever. If it's above 104 degrees for any period, you're deathly ill.

If the economy grows too slowly, or even contracts, it's obviously not healthy. But, if it grows too fast, that's not ideal, either. In fact, if GDP growth starts spiking above 4 percent for several quarters, it usually means there is an asset bubble. In the business cycle, the phase that follows expansion is the peak.

If nothing is done, the economy will go into a recession. That's because when the economy grows too fast, it overheats. There's too much money chasing too few real growth opportunities. Investors start putting excess money into mediocre investments. When they lose money, they panic. They start selling, causing more investments to lose money. It doesn't end until prices are low enough to stop the madness and attract investors again. 

The Federal Reserve is the nation's central bank. It uses monetary policy to keep the economy in the ideal zone. It raises interest rates if the economy is growing too fast, and lowers them if it's growing too slowly. The Fed tries to address the causes of the business cycle

Examples 

In 1999-2000, there was irrational exuberance around high technology stocks. By 1999, U.S. GDP growth was 5.1 percent in the third quarter and a whopping 7.1 percent in the fourth quarter. In 2005-2006, the asset bubble was in housing. The economy grew 4.3 percent in the first quarter of 2005, and 4.9 percent in the first quarter of 2006. During both bubbles, GDP growth spiked above 3 percent for several quarters in a row.

When GDP growth is above the ideal, it can also cause inflation. During 1999-2000, U.S. inflation was 2.7 percent-3 percent. Between 2003-2005, it was 3 percent to 4 percent. That's well above the 2 percent target inflation rate.

Once the bubble bursts, the economy enters the contraction phase of the business cycle. GDP growth usually falls off sharply and goes into negative territory, which signals a recession. During 2008-2009, U.S. GDP contracted in five quarters. Between 2000-2002, it only rose above 2 percent in one quarter and shrank in two quarters.

Healthy Rate of Growth Is 2 Percent to 3 Percent

Economists agree the optimal GDP growth rate is greater than 2 percent but less than 4 percent. In between the 2001 recession and the 2008 recession, the annual economic growth rate was healthy:

  • 2.9 percent in 2003.
  • 3.8 percent in 2004.
  • 3.5 percent in 2005.
  • 2.9 percent in 2006.
  • 1.9 percent in 2007.

During the 2008 recession, GDP growth rates were abysmal. The troubles in housing had spread to the investors in mortgage-backed securities, as the financial crisis infected the rest of the economy.

  • Q1 -2.3 percent
  • Q2 2.1 percent
  • Q3 -2.1 percent
  • Q4 -8.4 percent.

Obama Inherited an Unhealthy Economy

In March 2009, the new president launched the Economic Stimulus Program to spur the economy into health. Before it could be implemented, the first two quarters in 2009 were still negative. They returned to positive territory in the third quarter. 

  • Q1 -4.4 percent
  • Q2 -0.6 percent
  • Q3: 1.5 percent
  • Q4: 4.5 percent.

Growth rates in each quarter of 2010 were positive, edging into the 2-3 percent range. In 2011, the economy contracted in the first and third quarters. High foreclosures from the subprime mortgage crisis were preventing the housing market from recovering. Investors worried about a double-dip recession.

The Current Economy Is Healthy

Many analysts complain that the current U.S. recovery is unhealthy. They claim that attempts to spur economic growth have failed. Politicians assert their policies will restore growth to 3-4 percent rate. But, they don't realize that growth is, for the most part, within a healthy range. 

Here's GDP growth by each quarter since 2012. 

2012   2.2 Percent   Healthy

 Q1   3.2 percent  Healthy.
Q2   1.7 percent   Presidential campaign created uncertainty.
Q3   0.5 percent   Superstorm Sandy.
Q4   0.5 percent   Fiscal cliff. Sequestration. 

2013   1.8 Percent   Slow Growth
Q1   3.6 percent   Cold weather didn't impact sales.
Q2   0.5 percent   Exemption from payroll tax ended.
Q3   3.2 percent   Healthy.
Q4   3.2 percent   Government shutdown offset by auto sales. 

2014   2.5 Percent   Healthy
Q1   -1.0 percent  Inventory write down after weak holiday sales.
Q2   5.1 percent  Commercial construction.
Q3   4.9 percent   Bump in equipment spending.
Q4   1.9 percent   Almost healthy.

2015   2.9 Percent   Healthy
Q1   3.3 percent  Strong housing construction.
Q2   3.3 percent   Solidly healthy.
Q3   1.0 percent   Impact of strengthening dollar.
Q4   0.4 percent   Strong dollar slowed exports.

2016   1.6 Percent  Slow
Q1   1.5 percent   Stock market fell, reducing business investment.
Q2   2.3 percent   Home construction slowed.
Q3   1.9 percent   Auto sales, commercial construction grew.
Q4   1.8 percent  Consumer spending not enough to offset slowing exports.

2017  2.2 Percent   Healthy
Q1   1.8 percent   Government spending fell.
Q2   3.0 percent   Strong consumer confidence spurred spending.
Q3   2.8 percent   Continued strong consumer spending.
Q4   2.3 percent   Strong consumer spending on durable goods.

2018   
Q1   2.2 percent   Durable goods shipments fell.
Q2   4.2 percent   Shippers accelerated exports to avoid trade war.