What Is the Ideal GDP Growth Rate?
How Fast Should the US Economy Grow?
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 4.3% for the fourth quarter of 2020, according to the fourth quarter third estimate of the Bureau of Economic Analysis (BEA). This is the second consecutive quarter of growth, which is critical to recovering from the second quarter of 2020 when the economy suffered from the shutdowns put in place to prevent the spread of the COVID-19 pandemic. The GDP rate in Q2 was -31.4%.
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 may be 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 may be 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% over the longer run.
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 recession in 2020, which was caused by a pandemic.
Ideal vs. Actual GDP Growth Rates
In 1999, GDP growth reached 5.3% in the third quarter and peaked at 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 5%. 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 starting to recover from the worst quarterly downturn ever. It 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
|Q1||-5.0%||The government shut down the economy in March|
|Q3||33.4%||Recovery began as businesses reopened|
|Q4||4.3%||Recovery slowed as COVID-19 infections increased and some businesses closed again|
2019 GDP Growth Rates
|Q1||2.9%||Exports rose while imports fell|
|Q3||2.6%||Commercial construction fell|
|Q4||2.4%||Business spending fell|
2018 GDP Growth Rates
|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|
2017 GDP Growth Rates
|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|
2016 GDP Growth Rates
|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|
2015 GDP Growth Rates
|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|
- The ideal GDP growth rate is between 2% and 3%.
- The current GDP rate is 4.3% for the fourth quarter of 2020, which means the economy grew by that much between October and December 2020.
- The bounce in growth signaled partial recovery from the prior downturn seen in Q2 of 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.