“Just as supply-side factors such as increased productivity and plentiful labor drove robust growth amid continued disinflation in 2024, we would expect the next-most-likely scenarios to be supply-driven,” said Qian Wang, head of the Vanguard Capital Markets Model® (VCMM).
- Supply-side headwinds. A smaller labor force or reduced productivity could weigh on economic growth and usher in higher prices. Our baseline forecasts account for a degree of such headwinds developing.
- Soft landing. Inflation could return to trend while growth strengthens amid a productivity-induced “soft landing.” The Fed would have more leeway to cut the upper end of its target range to below 4%—but not too much, given our assessment that the neutral policy rate is around 3.5%. (The neutral rate is a theoretical interest rate that would neither stimulate nor inhibit demand in an economy at full employment.)
Less likely, Wang said, are demand-driven scenarios of recession and overheating.
- Recession: A hefty drop-off in demand could slow both growth and inflation significantly, forcing aggressive Fed rate cuts.
- Overheating: Expansionary fiscal policy could lift both growth and inflation, forcing the Fed to consider new rate hikes.
