What Is the Ideal GDP Growth Rate?

How Fast Should the Economy Grow?

young-workers.jpg
•••

Alvarez/Getty Images

A healthy gross domestic product (GDP) growth rate sustains the economy in the expansion phase of the business cycle for as long as possible. GDP is the total market value of the goods and services produced within a country in a year.

The GDP growth rate is how much more the economy produced than in the previous quarter. The current GDP rate is -31.4% for the second quarter of 2020. The economy suffered from the shutdowns put in place to prevent the spread of the COVID-19 pandemic.

A Healthy Rate of Growth Is 2% to 3%

In a healthy economy, growth, unemployment, and inflation are in balance. Most economists agree the ideal GDP growth rate is between 2% and 3%.

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

If the economy grows too slowly, or even contracts, it's not healthy. If it grows too fast, that's not ideal either.

If GDP growth starts spiking above 4% for several years, as it did between 1996 and 1999, it means an asset bubble is forming. When the economy grows too fast it overheats. There's too much money chasing too few real growth opportunities. Investors may start putting excess money into mediocre investments.

In the business cycle, the phase that follows expansion is the peak. If nothing is done, the economy could go into a recession. When investors lose money, many panic. They may start selling, causing more investments to lose money. It can end if prices fall low enough to stop the madness and attract investors again. 

The Federal Reserve, the nation's central bank, uses monetary policy to keep the economy in the ideal zone.

The Fed 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. Its target inflation rate is 2%.

The following chart visualizes the difference between a healthy growth rate and rates that are too high or too low. It features quarterly statistics from 1995 to 2020, showing how dangerously high growth rates were followed by recessions. The exception was the crash in 2020, which was caused by a pandemic.

Ideal vs. Actual GDP Growth Rates

In 1999, GDP growth peaked at 5.3% in the third quarter and 7.0% in the fourth quarter.

When GDP growth is above the ideal, it can cause inflation.

During 1999 and 2000, U.S. inflation was between 2.7% and 3%. That's well above the 2% target inflation rate.

In between the 2001 recession and the 2008 recession, the annual economic growth rate was healthy:

  • 2003: 2.9%
  • 2004: 3.8%
  • 2005: 3.5%
  • 2006: 2.9%
  • 2007: 1.9%

Between 2003 and 2005, inflation was between 3% and 4%. By 2006, an asset bubble formed in the housing market. The economy grew 4.5% in the first quarter of 2005 and 5.4% in the first quarter of 2006.

Once a bubble bursts, the economy enters the contraction phase of the business cycle.

In a contraction, GDP growth falls off sharply and goes into negative territory, which signals a recession. 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 2008: -2.3%
  • Q2 2008: 2.1%
  • Q3 2008: -2.1%
  • Q4 2008: -8.4%

In March 2009, the American Recovery and Reinvestment Act (ARRA) spurred the economy back into health. Before it could be implemented, the first two quarters of 2009 were still negative. They returned to positive territory in the third quarter. 

  • Q1 2009: -4.4%
  • Q2 2009: -0.6%
  • Q3 2009: 1.5%
  • Q4 2009: 4.5%

Growth rates in each quarter of 2010 remained positive, between 1.5% and 3.7%. 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.

Is the Current Economy Healthy?

The current economy is worse than it has been in almost 100 years. The severe downturn was caused by the COVID-19 pandemic and subsequent recession in 2020. The contraction of 31.4% in the second quarter of 2020 was worse than any year during the Great Depression.

2020 GDP Growth Rates

2020  Growth Rate Event
Q1 -5.0% The government shut down the economy in March
Q2 -31.7% Shutdowns continued

2019 GDP Growth Rates

2019 Growth Rate Event
Q1 2.9% Exports rose while imports fell
Q2 1.5% Exports fell
Q3 2.6% Commercial construction fell
Q4 2.4% Business spending fell
Annual 2019 2.2% Healthy

2018 GDP Growth Rates

2018  Growth Rate Event
Q1 3.8% Boost in commercial construction
Q2 2.7% Shippers accelerated exports to avoid a trade war
Q3 2.1% Exports fell due to trade war
Q4 1.3% Consumer spending slowed
Annual 2018 3.0% Healthy

2017 GDP Growth Rates

2017 Growth Rate Event
Q1 2.3% Government spending fell
Q2 1.7% Modest consumer spending
Q3 2.9% Strong spending on durable goods
Q4 3.9% Continued durable goods spending
Annual 2017 2.3% Healthy

2016 GDP Growth Rates

2016 Growth Rate Event
Q1 2.3% Stock market fell, reducing business investment
Q2 1.3% Home construction slowed
Q3 2.2% Auto sales, commercial construction grew
Q4 2.5% Consumer spending not enough to offset slowing exports
Annual 2016 1.7% Slow

2015 GDP Growth Rates

2015 Growth Rate Event
Q1 3.8% Strong housing construction
Q2 2.7% Durable goods spending
Q3 1.5% Strong dollar slowed exports
Q4 0.6% Commercial construction fell
Annual 2015 3.1% Very healthy

Key Takeaways

  • The ideal GDP growth rate is between 2% and 3%.
  • The current GDP rate is -31.4 for the second quarter of 2020, which means the economy contracted by that much between April and June 2020.
  • The GDP growth rate measures how healthy the economy is.
  • In March 2020, the government shut down the economy to protect against COVID-19, causing a recession.

Article Sources

  1. U.S. Bureau of Economic Analysis. "What Is GDP?" Accessed Oct. 5, 2020.

  2. Bureau of Economic Analysis. "Gross Domestic Product." Accessed Oct. 5, 2020.

  3. Bureau of Economic Analysis. “National Income and Product Accounts Tables: Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product." Accessed Oct. 5, 2020.

  4. Stanford University. "The Facts of Economic Growth," Page 3. Accessed Oct. 5, 2020.

  5. Bureau of Economic Analysis. “National Income and Product Accounts Tables: Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product," Select “Modify,” Select First Year "1996," Select “Refresh Table.” Accessed Oct. 5, 2020.

  6. Board of Governors of the Federal Reserve System. "What Economic Goals Does the Federal Reserve Seek to Achieve Through Its Monetary Policy?" Accessed Oct. 5, 2020.

  7. Bureau of Labor Statistics. "Consumer Inflation Higher in 2000," Page 2. Accessed Oct. 5, 2020.

  8. Federal Reserve Bank of San Francisco. "The Evolution of the FOMC’s Explicit Inflation Target." Accessed Oct. 5, 2020.

  9. Wharton School of the University of Pennsylvania. "The Real Causes — and Casualties — of the Housing Crisis." Accessed Oct. 5, 2020.

  10. Federal Reserve Bank of St. Louis. "Asset Bubbles: Detecting and Measuring Them Are Not Easy Tasks." Accessed Oct. 5, 2020.

  11. Bureau of Economic Analysis. “National Income and Product Accounts Tables: Table 1.1.1. Percent Change From Preceding Period in Real Gross Domestic Product," Select “Modify,” Select First Year "1999," Select “Refresh Table.” Accessed Oct. 5, 2020.