The U.S. economy in 2026: What to watch for | Stanford Institute for Economic Policy Research (SIEPR)
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The U.S. economy in 2026: What to watch for
Key takeaways<br>The U.S. economy has shown remarkable resilience in the face of policy uncertainty and AI’s potential disruption.<br>Interest rate decisions, the national debt, tariffs, worries about a stock market bubble and the low-hire, low-fire labor market are among the big economic issues that will take center stage in 2026.<br>Affordability will continue to be a top concern for consumers leading up to the November midterm elections.
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It’s a strange time for the U.S. economy. Last year, overall economic growth came in at a solid pace, fueled by consumer spending, rising real wages and a buoyant stock market. The underlying environment, however, was fraught with uncertainty, characterized by a new and sweeping tariff regime, a deteriorating budget trajectory, consumer anxiety around cost-of-living, and concerns about an artificial intelligence bubble.<br>Looking ahead to 2026, we anticipate that overall growth will continue apace, even as the job market has clearly slowed. We expect this year to bring increased focus on the Federal Reserve’s interest rates decisions, the weakening job market and AI’s impact on it, valuations of AI-related firms, affordability challenges (such as health care and electricity prices), and the country’s limited fiscal space.<br>In this policy brief, we dive into each of these issues, examining how they may impact the broader economy in the year ahead.<br>The Federal Reserve’s stagflation challenge<br>When it comes to the Fed’s forthcoming interest rate decisions, we expect this year to be a continuation of the unusual tensions of late 2025. The Fed has a dual mandate to pursue stable prices and maximum employment. In normal times, these two objectives are roughly correlated. An “overheated” economy typically presents strong labor demand and upward inflationary pressures, prompting the Federal Open Market Committee (FOMC) to raise interest rates and cool the economy. Vice versa in a slack economic environment.<br>But if the labor market continues to weaken and inflation remains above the Fed’s 2 percent target as President Trump’s tariffs trickle down to consumers, the Fed’s job in the coming year could become more complicated. The big concern is stagflation, a rare condition where inflation and unemployment both run high. Once it starts, stagflation can be hard to reverse. That’s because aggressive moves in response to spiking inflation can drive up unemployment and stifle economic growth, while lowering rates to boost economic growth risks driving up prices.<br>The stagflation risk is real. Towards the end of last year, the weakening job market said “cut,” while the tariff-induced price pressures said “hold.” In both speeches and votes on monetary policy, differences within the FOMC were on full display (three voting members dissented in mid-December, the most since September 2019). Most members clearly weighted the risks to the labor market more heavily than those of inflation, including Fed Chair Jerome Powell, though he did so while chanting the mantra that “there is no risk-free path for policy.” [1]<br>To be clear, in our view, recent divisions are understandable given the balance of risks and do not signal any underlying problems with the committee. The inherent ambiguity in the monetary-policy path out of stagflation was amplified by the disruption to the dataflow from the October government shutdown. We will not speculate on when and how much the Fed will cut rates next year, though market expectations are for two 25-basis-point cuts. We do expect that in the second half of the year, the data will provide more clarity as to which side of the stagflation dilemma, and therefore, which side of the Fed’s dual mandate, requires more attention.<br>Another key 2026 Fed development comes in May of this year, when Powell's term expires. Trump has aggressively attacked Powell and the independence of the Fed, stating unequivocally that his nominee will need to enact his agenda of sharply lowering interest rates. It is important to emphasize two factors that could influence these outcomes. First, even if the new Fed chair does the president's bidding, he or she will be but one of 12 voting members. Second, though Powell's term as chair is up in May, his 14-year term as a Fed governor runs until 2028 so it’s possible he could choose to remain. While very few former chairs have availed themselves of that option, Powell has made it clear that he views the Fed's political independence as paramount to the effectiveness of the institution, and in our view, recent events raise the odds that he'll stay on the board.<br>Trump’s tariff choice: Stay the course or retreat<br>One of the most consequential developments of 2025 was Trump’s sweeping new tariff regime. Acting through executive authority — much of which is currently under review...