Economic Outlook: Recovery Moving Quickly Thanks to Soaring Consumer Demand

Despite some disappointing economic data in May and June (jobs, inflation), we still think the economic recovery is moving quickly thanks to soaring consumer demand. In fact, we've increased our forecast for U.S. real GDP growth through 2025 by a combined 250 basis points since our February 2021 forecast. Our near-term forecasts are about in line with consensus.

The upgrade in our GDP forecast is primarily due to a reassessment of potential GDP. Because the demand side of the economy is so strong (thanks to fiscal stimulus, among other factors), the question of economic growth hinges on potential GDP, which represents the long-run supply side of the economy. We think the U.S. economy was operating below its potential even before the pandemic (in 2019). In particular, labor force participation was still running below its long-run trend, owing to the lingering impact of the Great Recession. However, we think exceptionally tight labor markets in the next few years will provide discouraged workers the opportunity to rejoin the workforce. This incremental labor market recovery should boost GDP growth through 2025. However, after 2025 we expect real GDP growth of about 2%, as the labor market recovery will be fully played out.

Consumer behavior is rapidly normalizing as people partake in services like restaurant dining and air travel again, which they eschewed during the height of the pandemic. Consumer goods spending has showed no signs of slacking in the second quarter, likely driven by continued spending of stimulus funds and excess savings accumulated in 2020. However, we expect goods spending to cool off in coming quarters, eventually driving the goods/services share of consumption back to its prepandemic level.

We think inflation will jump to around 3% for full-year 2021, the fastest rate since 2008. Partly, this is just a rebound from 2020 when the pandemic recession weighed on prices. But also, a slew of supply-side issues created pricing pressure. The semiconductor shortage has spilled over into many sectors, including autos, sending vehicle prices through the roof. Still, these are transient issues, meaning inflation in coming years is unlikely to be as high as in 2021. With that said, we do think that tight labor markets will put core inflation in the next few years slightly above the Federal Reserve's 2% target.