CLEVELAND, Ohio – What will inflation, possible tariffs and increases in productivity mean to the economy in 2025?
Edward Knotek, research director at the Federal Reserve Bank in Cleveland, talked about the solid growth he saw in the economy in 2024 and the outlook for 2025 as part of the FedTalk series Thursday.
“The economy is entering 2025 with solid momentum and healthy labor markets and inflation readings that are elevated, but well off their peaks,” said Knotek, who points out the views he expresses are his own and not necessarily those of the Cleveland Fed.
“A few key factors that will drive the economy this year include fundamentals that are supporting consumer and business spending, including confidence or sentiment measures, incomes and asset prices,” he said.
Additionally, Knotek pointed to potential changes in government policies as factors, including decisions on taxes and spending, tariffs, immigration policy and future monetary policy.
Knotek showed historical patterns based on statistical charts from 2024, and reported real gross domestic product grew by 1.6% in the first quarter, followed by even better figures of 3% and 3.1% in the second and third quarters. Fourth quarter results are not available yet, but according to Knotek, economists are estimating it will be between 1.5% and 2.75%.
Additionally, consumer spending played a big role in GDP growth, accounting for two-thirds of the growth.
Economists tend to believe GDP could step down to a pace just above 2% this year, Knotek said.
Mortgage rates continue to affect sales of new and previously owned single-family homes. Sales of both increased dramatically in 2020, but rises in home prices, the cost of materials and mortgage rates have cooled both markets.
Mortgage rates have doubled from 3.5% in 2022 to 7% at the end of 2024. Nationally, home prices have increased by 50% since early 2020.
Single-family housing starts is now slightly above prepandemic levels, Knotek said, and multifamily housing construction, which ramped up in 2021 and 2022, has recently slowed.
Manufacturing and industrial spending, which has been flat since mid-2022, has been improving over the past few months, Knotek said.
Knotek also said 2024 saw a healthy labor market, with wage growth of about 4% through the third quarter and increases in the number of people who are employed, which are both positively affecting consumer spending. Wealth has been rising, as well. Unemployment was at 4.1% at the end of 2024, up slightly from its more than 50-year low of 3.4%.
“While the unemployment rate has moved up from 2023, it is still low by historical standards,” Knotek said. He added that economists believe unemployment will not change much in 2025.
Over the past three months, employers have added 170,000 jobs per month on average, Knotek said, which is back to the prepandemic levels of 2019.
There are measures showing a “strong productivity growth” at the start of this year.
“An economic commentary that just came out of the Cleveland Fed [last] week estimates that there is a 40% probability that the economy has shifted into a high-trend productivity growth regime,” Knotek said.
He said AI is increasing productivity, but it takes a while for such advances to be fully integrated. And it’s still to be determined how much AI will be responsible for a long-term increase in productivity.
Knotek said though inflation has moderated over the past two years, it continues to be above the 2% goal of the Federal Open Market Committee, which means policy makers believe federal fund rates will continue to decline in 2025, but less than they did in 2024.
As to how possible tariffs would affect the economy, Knotek said it depends on whether consumers will substitute the tariffed goods for goods from other countries, or substitute domestic items.
“How willing people are to substitute to other goods, how willing businesses are to accept lower profits, how robust and flexible supply chains are, how much substitution there would be from other countries – there are a lot of channels at play,” Knotek said.
Knotek said as long as the economy remains strong, he still sees long-term projects happening in the form of large investments in the growing need for electricity, computer capacity, electric vehicles and AI.
Though most of Knotek’s talk focused around national trends, he said the economic trends in the Fed’s fourth district, which includes Ohio, eastern Kentucky, the northern panhandle of West Virginia and western Pennsylvania, are similar.
Russell Mills, senior regional officer of the Cleveland Fed, said he and co-author Brett Huettner just published a report on the employment recovery post-pandemic in the fourth district compared with the rest of the country. The report shows an overall lag in the recovery in this region between February 2020 and March 2024.
While overall metro areas across the country averaged employment recovery improvement of 3.8%, the Youngstown-Warren metro area improved by 0.6%.
The complete report can be found HERE.
Pictured at top: A shopper passes a display of televisions on sale in a Costco warehouse in Colorado Springs, Colo., on June 22, 2023. (AP Photo | David Zalubowski)