The Fed met just before Christmas and revealed their latest projections for 2025. The good news from that meeting is that they cut their target interest rate once again, bringing the federal funds rate down to as low as 4.25 percent.
Yet, Macrosight could not help but notice a bit of pessimism in their published projections. The Fed’s forecast for GDP for 2025 is only 2.1 percent, lower than the expected value for 2024 of 2.5 percent. This is in spite of the fact they have lowered the federal funds rate at total of 100 basis points since September.
Macrosight decided we could not abide starting out 2025 on such a pessimistic forecasting note (there is plenty enough to be concerned about as it is). To investigate the Fed’s pessimism, Macrosight decided to do its own forecast.
Macrosight’s GDP Forecast
Macrosight’s 2025 forecast for real GDP growth is 2.6 percent. Figure 1 displays real GDP growth from 2021 through 2024 along with that forecast for quarterly GDP through the end of 2025. These quarterly forecasts were generated with a standard (and simple) forecasting model with the inputs being the previous two quarters of real GDP growth (and the weights estimated on data spanning 1985Q1 through 2024Q4). This simple forecasting model is Macrosight’s “baseline model,” as explained in a couple of previous posts (here and here).1
The forecast for 2.6 percent growth over 2025, as it turns out, is the same as the (expected) average for 2024.2
Macrosight’s forecasted value for 2025 is also about half-point higher than what the Fed is expecting (again, 2.1 percent, as shown here).
Admittedly, Macrosight’s forecast is not very exciting. But at least it’s not as pessimistic as the Fed’s!
Macrosight’s Assumptions
Macrosight’s model predicts a similar growth rate in 2025 as 2024—2.6 percent— since real GDP growth has been stable the past few quarters.3 In forecasting, when cyclical data is stable, the predicted future values of that data will also be stable. Since past values of the variable are key inputs for any forecasting model (as explained here), the forecast will naturally be a function of those past values. Hence, Macrosight’s forecast for GDP growth for 2025 is the same, on average, as what occurred in 2024.
What could change the forecast? “Shocks,” a.k.a, changes in important economic variables.
Macroeconomists like to think in terms of “shocks,” unexpected events that “hit” the macroeconomy (or the nation in general). Shocks include anything that would cause a deviation from predicted spending plans. This is why most published forecasts will be explained in terms of “scenarios.” Some entity, for example, might state “We, Very Important Investment Bank, predict real GDP growth for 2025 to equal 2.0 percent. If the Federal Reserve Interest rate cuts lift consumer sentiment, we expect that estimate to rise to 2.5 percent. If the threat of terrorism increases, GDP growth may be as low as 0.5 percent.” Or something like that.
Macrosight provided a “scenario” in this regard in this post, assessing how the Fed’s interest rate cuts may affect GDP Growth. In the forecasts reported in that post, Macrosight surmised that a decline in the interest rate of 70 basis points would boost GDP growth by an extra half of a percent. So, if Macrosight was going to be even more optimistic, we could adjust the 2.6 percent estimate for 2025 upward to, say 3.1 percent or so.
That upward adjustment is based on the idea that the forecasted values shown in Figure 1 are “baseline.” They are based on the most recent data and that recent data may not yet reflect the impact of the Fed’s rate cuts. If the effect of those cuts are still to be felt, then one should be even more optimistic about GDP growth in 2025.
Explaining the Fed’s Pessimism
In light of Macrosight’s baseline forecast, it must be the case that the Fed is much more concerned about the macroeconomy than their boilerplate-ish press release reveals. The Fed cut rates by a total of 100 basis points this fall, yet they only expect GDP to barely top its long run average.4 In that respect, they view those cuts—and the expected cuts in 2025 (also evident in the projections)—as keeping real GDP afloat in 2025 against forthcoming but as yet-unknown negative “shocks.” Otherwise, an optimistic view would be that the rate cuts will give the economy a jolt enough to achieve a growth rate like the 3.2 percent from 2023.
Alternatively, it may not be pessimism, per se. Rather, the Fed may view GDP growth of around 2 percent as “normal,” and the recent rate cuts have helped ensure that normal. Indeed, in the aforementioned press release, the Fed states that the “risks to achieving its employment and inflation goals are roughly in balance” (italic emphasis added by Macrosight).
By that description—in balance—rather than being pessimistic, the Fed appears to be saying “not sure, we’ll see.” Macrosight’s view provides a bit more optimism than that. But, that is all we can do right now, wait and see. In the meantime, Macrosight will track how its forecast holds up as the year goes on.5
For example, I used this baseline model for the Macro Madness post from March 2024. The only difference for today’s post is the I estimated on data through the end of 2024.
For the fourth quarter of 2024, I used the latest “nowcast” for that quarter from the Atlanta Federal Reserve Bank. The average over the first three quarters is 2.54 percent. If you add in the expected 2.7 percent for the fourth quarter (from the “nowcast), the average becomes 2.58 percent (rounded up to 2.6 percent in Figure 1).
I say similar since if I displayed the numbers to the second decimal there would be slight variation to the quarterly estimates.
The Fed’s estimate of “longer run” GDP is 1.8 percent, shown in the projections, and discussed in detail by Macrosight here.
Macrosight’s forecast from March 2024 for the last three quarters of 2024 equaled . . . 2.6 percent. See Figure 2 in the Macro Madness post.