The new GDP and employment numbers are out, and they confirm something I have been arguing for a while, namely: the US economy is slowing down, but it is not in a recession, and the tariffs did not cause the stagflation that so many commentators confidently predicted.
Real GDP growth slowed again in the most recent quarter, but it still expanded at about 1.4 percent. Real GDP growth is slower than in 2024, but it was still above 2 percent (see below). That is clearly below the pace we saw in the immediate aftermath of the pandemic, when fiscal expansion and the reopening of the economy generated unusually strong growth. But it is still positive growth. As in previous quarters, consumption remains the central driver of the economy, which should not be surprising in a country where household spending accounts for roughly seventy percent of GDP.
The more worrisome component in the GDP report is actually government spending, which fell significantly. This decline reflects the wave of layoffs of federal workers and the broader push toward fiscal restraint that has accompanied the current administration, including falling nondefense spending. In other words, a certain degree of austerity has been quietly introduced into the federal budget, with a negative bias with respect to social spending. That matters because the rapid recovery of the US economy after the pandemic owed a great deal to fiscal expansion. As that support fades, or is actively reversed (although I doubt that) the economy naturally settles into slower growth.
On the labor market side, the most recent BLS employment report shows a decrease of about 92,000 jobs. That is certainly weak by the standards of the last few years, but it is not yet consistent with a recession. A lot of this was caused by a major, four-week, strike involving over 30,000 nurses and health care workers. Unemployment remains relatively low, and the labor market appears to be softening rather than collapsing. In other words, what we are seeing is broadly consistent with what macroeconomic theory would predict: when growth slows, job creation also slows. Okun’s law still works.
The decline in federal employment is part of that story. But here again there is an interesting political twist. While civilian federal jobs have been cut, the administration has promised a significant increase in military spending, which is likely to offset some of the contractionary effects of austerity elsewhere. This is not exactly a new strategy. Economists used to call it military Keynesianism, using defense spending to sustain demand when other forms of public spending are politically difficult.
All of this confirms something that was widely disputed last year. The tariffs did not trigger the recession that so many analysts predicted. Nor did they produce a surge in inflation. They also did not bring back manufacturing jobs, but that isn't a surprise either (on that see this post). As I argued repeatedly, tariffs might produce a one-time increase in the level of prices, but that is very different from generating persistent inflation. And the effect was small, with CPI increasing by less than it did in 2024 (see figure above). The data have borne this out. Inflation has remained relatively subdued, and the economy, while slowing, continues to grow.
That does not mean the risks have disappeared. In fact, the risks may now be higher than they were earlier in the year, but for reasons that have little to do with tariffs. The most important new development is the war with Iran and the sharp increase in oil prices. Since the beginning of the conflict, oil prices have risen by more than 25 percent (see below). Energy shocks have historically played an important role in US inflationary crises, including the Pandemic. Higher oil prices increase production costs, push inflation and squeeze household budgets. The affordability issue (like the Epstein files) might not go away.
On the labor market side, the most recent BLS employment report shows a decrease of about 92,000 jobs. That is certainly weak by the standards of the last few years, but it is not yet consistent with a recession. A lot of this was caused by a major, four-week, strike involving over 30,000 nurses and health care workers. Unemployment remains relatively low, and the labor market appears to be softening rather than collapsing. In other words, what we are seeing is broadly consistent with what macroeconomic theory would predict: when growth slows, job creation also slows. Okun’s law still works.
The decline in federal employment is part of that story. But here again there is an interesting political twist. While civilian federal jobs have been cut, the administration has promised a significant increase in military spending, which is likely to offset some of the contractionary effects of austerity elsewhere. This is not exactly a new strategy. Economists used to call it military Keynesianism, using defense spending to sustain demand when other forms of public spending are politically difficult.
All of this confirms something that was widely disputed last year. The tariffs did not trigger the recession that so many analysts predicted. Nor did they produce a surge in inflation. They also did not bring back manufacturing jobs, but that isn't a surprise either (on that see this post). As I argued repeatedly, tariffs might produce a one-time increase in the level of prices, but that is very different from generating persistent inflation. And the effect was small, with CPI increasing by less than it did in 2024 (see figure above). The data have borne this out. Inflation has remained relatively subdued, and the economy, while slowing, continues to grow.
That does not mean the risks have disappeared. In fact, the risks may now be higher than they were earlier in the year, but for reasons that have little to do with tariffs. The most important new development is the war with Iran and the sharp increase in oil prices. Since the beginning of the conflict, oil prices have risen by more than 25 percent (see below). Energy shocks have historically played an important role in US inflationary crises, including the Pandemic. Higher oil prices increase production costs, push inflation and squeeze household budgets. The affordability issue (like the Epstein files) might not go away.
But the key channel here is not simply inflation. The real issue is the Federal Reserve’s reaction to these cost pressures. Throughout last year I have argued that the main recession risk comes from monetary policy, not trade policy (and to a lesser extent fiscal policy). The Fed kept interest rates relatively high for a prolonged period in order to combat inflation after the pandemic. Those high rates have already slowed residential investment and put pressure on consumption through higher mortgage rates and credit costs. If oil prices push inflation slightly higher again, the Fed may become even more reluctant to reduce interest rates further. Kevin Warsh was a hawk before he wasn't.
In other words, the oil shock could reinforce the Fed’s cautious stance and delay the easing of monetary policy. That would prolong the period of tight credit conditions and increase the risk that the slowdown eventually turns into a recession. Ironically, this means that the biggest macroeconomic danger today comes not from tariffs, not from supply chains, and not from the uncertainty that commentators love to invoke. It comes from the interaction between energy prices and monetary policy.
PS: My view has been more or less in line with the results of the Fair model forecasts. He sees a slowdown of growth and a small increase in inflation (last one was before the Iran war).
In other words, the oil shock could reinforce the Fed’s cautious stance and delay the easing of monetary policy. That would prolong the period of tight credit conditions and increase the risk that the slowdown eventually turns into a recession. Ironically, this means that the biggest macroeconomic danger today comes not from tariffs, not from supply chains, and not from the uncertainty that commentators love to invoke. It comes from the interaction between energy prices and monetary policy.
PS: My view has been more or less in line with the results of the Fair model forecasts. He sees a slowdown of growth and a small increase in inflation (last one was before the Iran war).
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