What Is the Ideal GDP Growth Rate?
How Fast Should the Economy Grow?
The healthy gross domestic product growth rate is one that is sustainable so that the economy stays in the expansion phase of the business cycle as long as possible. Gross domestic product is the nation's entire economic output for the past year. The GDP growth rate is how much more the economy produced than in the previous quarter. Many economists place the ideal GDP growth rate at 2%.
In a healthy economy, unemployment and inflation are in balance. The lowest level of unemployment that the U.S. economy can sustain is between 3.5% and 4.5%.
The Federal Reserve's target inflation rate is 2%. You'd think the more growth, the better off the economy would be. 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 deathly 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 quarters, it 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 recession. 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.
Between 1995 and 2001, there was a lot of irrational exuberance around many high technology stocks. By 1999, U.S. GDP growth was about 6.1% year over year in the third quarter and 6.5% year over year in the fourth quarter. In 2005 and 2006, the asset bubble was in housing. The economy grew 4.3% in the first quarter of 2005 and 4.9% in the first quarter of 2006. During both bubbles, GDP growth spiked above 3% for several quarters in a row.
When GDP growth is above the ideal, it can also cause inflation. During 1999 and 2000, U.S. inflation was between 2.7% and 3%. Between 2003 and 2005, it was between 3% to 4%. That's well above the 2% target inflation rate.
Once the bubble bursts, the economy enters the contraction phase of the business cycle. GDP growth falls off sharply and goes into negative territory, which signals a recession. During 2008 and 2009, U.S. GDP contracted in five quarters. Between 2000 and 2002, it only rose above 2% in one quarter and shrank in two quarters.
Healthy Rate of Growth Is 2% to 3%
The following chart visualizes the difference between a healthy growth rate, and a potentially destructive growth rate. It features statistics from 1995-2018, illustrating that a dangerously high growth rate could lead to an asset bubble.
Many economists agree the optimal GDP growth rate is greater than 2% but less than 4%. In between the 2001 recession and the 2008 recession, the annual economic growth rate was healthy:
- 2.9% in 2003
- 3.8% in 2004
- 3.5% in 2005
- 2.9% in 2006
- 1.9% in 2007
During the 2008 recession, GDP growth rates grew 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%
- Q2: 2.1%
- Q3: -2.1%
- Q4: -8.4%
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: -6.7%
- Q2: -0.7%
- Q3: 1.7%
- Q4: 3.8%
Growth rates in each quarter of 2010 were positive, between 2.3% and 3.9%. 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
Here's GDP growth for each quarter from 2012 until Q3 2018, the last quarter for which data is available as of January 2019:
2012 2.2% Healthy
- Q1: 3.2% - Healthy.
- Q2: 1.7% - Presidential campaign created uncertainty.
- Q3: 0.5% - Hurricane Sandy.
- Q4: 0.5% - Fiscal cliff. Sequestration.
2013 1.8% Slow Growth
- Q1: 3.6% - Cold weather didn't impact sales.
- Q2: 0.5% - Exemption from payroll tax ended.
- Q3: 3.2% - Healthy.
- Q4: 3.2% - Government shutdown offset by auto sales.
2014 2.5% Healthy
- Q1: -1.0% - Inventory write-down after weak holiday sales.
- Q2: 5.1% - Commercial construction.
- Q3: 4.9% - Bump in equipment spending.
- Q4: 1.9% - Almost healthy.
2015 2.9% Healthy
- Q1: 3.3% - Strong housing construction.
- Q2: 3.3% - Solidly healthy.
- Q3: 1.0% - Impact of strengthening dollar.
- Q4: 0.4% - Strong dollar slowed exports.
2016 1.6% Slow
- Q1: 1.5% - Stock market fell, reducing business investment.
- Q2: 2.3% - Home construction slowed.
- Q3: 1.9% - Auto sales, commercial construction grew.
- Q4: 1.8% - Consumer spending not enough to offset slowing exports.
2017 2.2% Healthy
- Q1: 1.8% - Government spending fell.
- Q2: 3.0% - Strong consumer confidence spurred spending.
- Q3: 2.8% - Continued strong consumer spending.
- Q4: 2.3% - Strong consumer spending on durable goods.
- Q1: 2.2% - Durable goods shipments fell.
- Q2: 4.2% - Shippers accelerated exports to avoid a trade war.
- Q3: 3.4% - Exports fell due to trade war.
- Q4: 2.2% - Consumer spending slowed.
- Q1: 3.1% - Exports rose while imports (which slow growth) fell
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Federal Reserve. "What Are the Federal Reserve’s Objectives in Conducting Monetary Policy?" Accessed Jan. 2, 2020.
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Federal Reserve Bank of St. Louis. "Gross Domestic Product." Accessed Jan. 2, 2020.
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