The ideal growth rate of Gross Domestic Product (GDP) is that rate which is neither too hot nor too cold, but rather moderate. This rate aims to maintain economic sustainability during the expansion phase of the business cycle for as long as possible. GDP is defined as the total market value of goods and services produced in a country over one year.
Why does a healthy GDP growth rate matter to you?
In a healthy economy, growth, unemployment, and inflation are in balance. Most economists agree that the ideal GDP growth rate ranges between 2% and 3%. Many politicians believe that more growth is always better. The healthy GDP growth rate is akin to the human body’s normal temperature of 98.6 degrees. If your temperature is below the ideal, you know you’re sick. You might be on the brink of death if it’s too low. A higher temperature can also mean that you’re unwell. If it’s above 100 degrees, you have a fever. If it’s above 104 degrees for a long time, you might be seriously ill.
Note: If the economy is growing slowly or even contracting, that is not healthy. On the other hand, if growth is too rapid, that is not ideal either. There may be an asset bubble if GDP growth begins to rise above 4% for several years, as occurred between 1996 and 1999. The economy starts to overheat when it grows too quickly. An overheated economy is unsustainable because it cannot meet the demands of consumers, businesses, and government.
The natural unemployment rate declines. Prices for everything from paper towels to stocks rise. The economy quickly begins to contract. A recession becomes likely unless actions are taken to return everything to a slowly increasing growth rate.
Note: The Federal Reserve, the country’s central bank, uses monetary policy to influence inflation and economic activity.
The Federal Reserve raises the target range for the federal funds rate to increase interest rates if the economy spreads too quickly. When the economy contracts, the Federal Reserve lowers the rate. Using these tools and other monetary policy instruments, the Federal Reserve attempts to keep inflation at 2% in the long term. This helps manage GDP growth at the same time. If inflation rises too quickly, consumers spend more because their money will lose value in the future.
The following chart illustrates the difference between a healthy growth rate and rates that are either too high or too low. The chart includes quarterly statistics from 1995 to 2021 and shows how recessions closely follow dangerously high growth rates. The exception was the recession in 2020 caused by the pandemic.
Historical Economic Growth Rates
During 1999 and 2000, inflation in the United States was between 2.2% and 3.4%. While these rates are ideal according to the Federal Reserve, the bank did not start targeting long-term inflation until 2012.
Between the recession of 2001 and the recession of 2008, the annual economic growth rate was healthy:
- 2003: 2.8%
- 2004: 3.9%
- 2005: 3.5%
- 2006: 2.8%
- 2007: 2.0%
Between 2003 and 2005, inflation ranged from 2.3% to 3.4%. The economy grew by 4.5% in the first quarter of 2005 and by 5.5% in the first quarter of 2006. The asset bubble in the housing market began to grow by the end of 2006.
Note: Once the bubble bursts, the economy enters a contraction phase of the business cycle.
Falls
The economic growth rate enters negative territory in the case of an economic contraction. This can indicate that the economy is in trouble. If the contraction lasts for more than two consecutive quarters, it suggests a likelihood of approaching recession.
During the 2008 recession, economic growth rates were poor. Problems in housing spread to investors in mortgage-backed securities, as the financial crisis spread to the rest of the economy:
- Q1 2008: -1.6%
- Q2 2008: 2.3%
- Q3 2008: -2.1%
- Q4 2008: -8.5%
The American Recovery and Reinvestment Act (ARRA) brought the economy back to health in March 2009. The first two quarters of 2009 were still negative before ARRA started to impact the economy. Growth rates returned to positive territory in Q3:
- Q1 2009: -4.6%
- Q2 2009: -0.7%
- Q3 2009: 1.5%
- Q4 2009: 4.3%
Growth rates remained positive in every quarter of 2010, between 2.0% and 3.9%. The economy contracted in the first and third quarters of 2011. High legal proceedings from the subprime mortgage crisis were preventing the housing market from recovering.
Can GDP alone tell us if the economy is healthy?
Economic growth is one of the most commonly used measures that economists track to determine if the national economy is functioning smoothly, but it is just one of many metrics used to assess a healthy economy. If GDP and its growth are considered alone, the economy is doing well if these measures are positive or negative only for a short time.
However, economists consider other metrics to get a full picture of the economic situation. Some of these metrics include unemployment rate, consumer price index, purchasing managers’ index, and others.
Here are the quarterly growth rates for 2021 and the previous five years:
- Growth rate for 2021:
- Q1: 6.3% – Recovery continues and Delta variant spreads
- Q2: 6.7% – GDP growth continues and Delta variant spreads
- Q3: 2.3% – Slowdown due to decreased consumer spending
- Q4: 6.9% – Recovery continues despite the spread of the Omicron variant
- Annual for 2021: 5.7% – Hot economy
- Growth rates for 2020:
- Q1: -5.1% – Government shut down the economy in March
- Q2: -31.2% – Continued shutdowns
- Q3: 33.8% –…
Source: https://www.thebalancemoney.com/what-is-the-ideal-gdp-growth-rate-3306017
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