We’re reasonably optimistic for global growth, not too far from the 3.2% projected by the International Monetary Fund. However, we expect large regional differences. While we project a very solid 2.5% growth in the United States, well above the consensus, our projections are below the consensus for Europe. In the US, I believe that the growth drivers precede the policy changes we are likely to see in the new administration. Chief among them is a strong increase in real disposable household incomes due to the decline in price inflation, which is much sharper than the decline in wage inflation. With ongoing employment growth, a strong stock market and improving outlook for the housing market in the mix, we are more upbeat about consumer strength than many of our peers.

I believe that many market participants have exaggerated the importance of certain factors, like the increases in auto loan and credit card delinquencies. What’s apparent in these sectors is just a normalization after an incredibly strong period for household credit quality. Consumers came out of the pandemic flush with cash and savings have been decreasing for the past quarters, so you’ll naturally see some adjustments. Real disposable income growth, however, is the most important measure because it determines spending.

They have definitely contributed to improving financial conditions for households. The rate hikes in 2022 and the first half of 2023 were a massive drag because markets were building them into long-term interest rates, which made credit less accessible and weighed on equity prices. In the year ahead, improving financial conditions should contribute about half a percentage point to economic growth.

The productivity trend in the US has been rather strong. On aggregate, we have seen annualized increases of about 1.8% since late 2019 – a faster growth pace than in the decade before the pandemic. Over the next year or so, I would expect similar numbers. Meanwhile, labor force growth is almost certainly going to come down. It developed extremely strong because of the large immigration wave of 2023, which is already abating quite sharply and will trail off further as we move into next year. Slowing labor force growth is one of the downside risks during the Trump administration and one of the reasons why we expect US growth to slow modestly to 2.5% next year from 2.8% this year.

The Fed has already shifted away from a very singular focus on inflation. Over the summer, we actually saw a very sharp move after the jump in unemployment in the Department of Labor’s July report. That was visible in the run-up to the 50 basis point  rate cut in September. Since then, job market figures have been more reassuring and the Fed has returned to a greater balance with regard to its dual mandate. Still, the labor market has been featured much more prominent in central bank strategy simply because inflation is much closer to the target than it was a year or two ago. If it comes down further and labor market utilization remains high, both of these factors should lead to additional monetary policy easing.

That always depends on the specific data flow. I believe that four more cuts by 25 percentage points are very realistic for 2025. Our baseline assumption is that we’ll eventually settle at a Fed Funds Rate of 3.25 to 3.5%, significantly higher than it was before the pandemic. However, the 2008 financial crisis was an extraordinary event that lead to rates being lowered into theretofore-unknown territory. The global economy was still winding down a lot of the excesses of the pre-crisis period and healing from the downturn. That creates skewed comparisons, leading a lot of people to overshoot in their estimates of equilibrium interest rates. Now, we’re in a somewhat more normal environment.

Quantitative tightening has moved very much out of the view of the public eye and rightfully so – it’s not the active tool of monetary policy. I don’t expect the Fed to be particularly nimble because it wants to turn its balance sheet reduction into a very boring exercise. Central bankers want to bring it down to levels that are sufficient to satisfy the reserve requirements of the banking system, which are certainly much greater than they were before 2008. They reduced the pace of the runoff earlier in the year to approach the minimum level of necessary reserves more slowly and with more room to react in case there are signs of tightness in the market. I would expect them to keep reducing the balance sheet at the current pace for another three months and then slowly let it taper out.

The US budget is undoubtedly on an unsustainable path. It’s impossible to continue running primary deficits of 3% of GDP in perpetuity – unless you have an unbelievably lucky draw in terms of real interest rates relative to the growth rate of the economy. If real rates don’t fall moderately below the growth rate of the economy, the debt-to-GDP ratio and debt service to tax receipt ratio are only going to increase further. At some point, that will result in a crisis. That point might not necessarily be close given the fiscal capacity of the United States and the global appetite for Treasuries. However, the term premium will continue to creep up.

They’re significant for mortgage and corporate borrowers because their borrowing costs are priced off of government bond rates. Increases can weigh on financing and economic activity. And if debt to GDP or debt service to GDP ratios move outside the historical range, market participants will be worried that they will deteriorate even faster going forward. Any increase of the debt to GDP ratio by 10 percentage points probably translates into a 10 to 30 basis point climb of the term premium. While these numbers are not dramatic and I don’t think that financial stability will deteriorate drastically, spillover effects into foreign financial markets are definitely possible in case of a fiscal reckoning in the US.

There is no obvious catalyst for major fiscal adjustments right now. The government can’t cut back on its debt service expenses without losing the trust of the financial markets and it can’t reduce its defense spending because we live in a more dangerous world. Neither political side in Congress can really touch spending for social security and medical insurance because voters from low-income backgrounds would react very negatively to that. Furthermore, Republicans won’t raise taxes on upper income individuals and corporations…

We don’t expect a broad cut to the corporate tax rate. It’s likely going to stay at or near the level of 21% it reached during the first Trump administration. However, for domestic manufacturers we are assuming a cut to 15%. While that in itself is not going to be an extremely expansive fiscal measure, the bigger issue is that the deficit, at roughly 6% of GDP, is already very large. It would have increased under any outcome of the US presidential elections, so the path to a more sustainable fiscal situation is unclear.

In our baseline we predict 20 percentage point tariff increases on China, and we’re also building in an auto tariff on the European Union and a tariff on electric vehicle imports from Mexico. That should translate into a 40 basis point increase in US inflation. However, I don’t believe that these developments will matter much to the Fed, because they’re price-level increases and thus less important for optimum monetary policy than ongoing inflation effects. That’s a view that Fed Governor Christopher Waller actually confirmed to me at the ECB forum in Sintra in July.

A negative growth effect of some magnitude is likely, but harder to estimate than the positive inflation effect. There are much more moving parts involved: How is uncertainty around trade policy going to affect business investment and capital spending? How will financial markets react? In any event, the negative effect these tariffs will have on GDP growth could be more important to monetary policy than price-level increases. During the first Trump administration, financial markets reacted very negatively to new tariffs and the Fed ended up cutting rates three times in a row. It’s important to note that nobody knows how significant these trade penalties will end up being, but I think we are going to see additional monetary policy easing in support of the economy.

The effect on the US energy sector is going to be indirect. We expect China’s growth to slow to 4.5% in 2025, in line with the consensus view. An average 20 percentage point US tariff increase on imports from China should hit the country’s economy by roughly 70 basis points. However, accommodative fiscal and monetary policies out of Beijing are likely to offset these decreases by more than half. Of course, an economic slowdown in China weighs on global oil demand and prices, but for the US energy industry, the relationship with Canada is much more important and direct – and energy is bound to be exempt from any US tariffs on Canada. China, meanwhile, faces other significant challenges…

Correct, and as we’ve seen time and again in the US as well as East Asia and Japan, a housing market crisis is very difficult to stem through government policy. These developments always take a long time to unwind, which leads us to believe that further deceleration in China is probable beyond 2025.

Much like our outlook for Europe overall, our view on Germany’s growth prospects is below the consensus. Germany is much more affected by uncertainty around trade policy than other European economies because it’s even more export-oriented. In addition, the issue of high energy costs is quite significant. Decisions made over the past 20 years – like shutting down nuclear reactors and relying heavily on Russian gas – are coming back to haunt Germany. China, which provided strong tailwinds to the German economy as long as it was technologically lagging, has become less reliable as an export market and instead turned into a competitor. That’s why I believe German economic growth will end up close to zero in 2025. On the other hand, Germany’s low debt to GDP ratio is a positive – at least in principle. The government possesses a lot of fiscal space to address infrastructure issues, while investments in liquefied natural gas should pay off in the long term. However, the political uncertainty around and beyond the elections in February is challenging as well.

In the medium to long run, AI is potentially going to be a very important factor. We upgraded our long-term growth estimates for the US a little over a year ago, from 1.8% real GDP growth in the early 2030s to 2.2%. For other advanced economies, we made broadly similar changes because of the AI boom. Even if you don’t make aggressive assumptions about artificial general intelligence, you just have to look at the lower and middle value-added white collar tasks – over a 10 to 15-year period, 25% of work hours could be replaced by AI. That should result in a sizeable boost to productivity.

Yes, but we should be realistic. All the big general purpose technologies needed decades to really make their presence felt in economic statistics. I do believe that the lags are declining: Electricity took almost a century before resulting in broad and major productivity gains, computers and the internet took several decades. Artificial intelligence won’t take many decades to be a decisive force – but it won’t just be a few years either. Even the most innovative firms are still in the process of figuring out the best way to utilize the technology for real productivity gains. Since the US is a huge economy with a nominal GDP of almost 30 trillion dollars, it’s going to take time for any innovation to move the needle.

The AI boom is not tied to the political cycle, so I believe we would have seen rapid development under any administration. Beyond that, I do believe that certain industry-specific policies and regulations are going to become more accommodative. Merger policy and antitrust regulation, for example, are likely going to be much less restrictive. Financial regulation has significantly tightened in the past years – that’s probably going to ease off to some degree as well. However, we don’t expect a big shift away from the framework installed after the 2008 financial crisis. In terms of energy policy, I believe we are going to see more drilling on federal land and other measures to develop larger energy supplies. In any of these cases, industries are going to be driven more by economic fundamentals than the regulatory environment.

The energy industry is a great example. While the Biden administration was clearly more regulation-minded and assigned a higher importance to environmental issues than the Trump administration will, US oil production grew sharply and reached historical records in the past four years. Conversely, under Trump, the large amount of spare capacity in global oil production could well offset looser regulation in terms of investments into additional drilling rigs. This might result in more muted production growth in coming years.