The 2025 economy was a mixed bag. By several indicators, it performed well: economic growth was strong, with output increasing by about 4% in both the second and third quarters. The unemployment rate remained low throughout the year—4.4% as of September, the most recent month with available data due to the government shutdown.
Yet there are clear red flags. Inflation stands at 3%, one percentage point above the Federal Reserve’s 2% target and the average inflation rate prior to the pandemic. The difference between 2% and 3% inflation may not sound substantial, but it is. Because inflation reflects the growth rate of prices, a sustained 3% rate compounds to significantly higher prices than a 2% rate over time. For example, 3% inflation results in roughly double the loss of purchasing power over 70 years compared with 2% inflation. It is also important to remember that declining inflation does not mean prices are falling—only that they are rising more slowly.
This is why consumers are not seeing lower prices at the grocery store.
“The 2025 economy was a mixed bag. By several indicators, it performed well. Yet there are clear red flags.”
Job growth has been disappointing since May. A healthy economy typically creates about 120,000 new jobs per month, but since May, monthly job creation has averaged only about 38,000. The manufacturing sector has fared even worse, shedding jobs every month during this period for a total loss of 47,000.
I believe weak job growth is largely due to the “Liberation Day” tariff package announced in April. As of 2024, at least two-thirds of U.S. imports were not final consumer goods competing with American-made products but rather raw materials and other inputs used by U.S. manufacturers. Tariffs therefore increase production costs for American firms, leading to higher consumer prices, lower producer profits, and reduced hiring. If the Supreme Court rules that these tariffs are constitutional, I expect continued weak job growth in 2026 and a stock market correction.
Weak job growth is likely why the Federal Reserve has backed off its inflation fight. The Federal Reserve aggressively increased interest rates between 2022-2024 to reduce inflation to its pre-pandemic level but has resumed cutting rates despite inflation being above target. The Federal Reserve, by statute, has a dual mandate; keep unemployment low and prices stable. The Federal Reserve cannot simultaneously address both mandates, but usually only is an issue, either unemployment or inflation is high. The current economy presents the Federal Reserve with a dilemma: cut rates and let inflation remain above target or increase rates, drive inflation down to target but further weaken job growth. The Federal Reserve appears to be choosing the former, which leads me to think inflation will run hot in 2026.
Ultimately, the trajectory of the 2026 economy will depend largely on two factors: tariffs and Federal Reserve actions. Together, they will shape the path of economic growth, job creation, and inflation—along with any unforeseen developments.
