What Is the Ideal GDP Growth Rate?

What Is the Ideal GDP Growth Rate?

A healthy GDP growth rate keeps the economy in the expansion phase of the business cycle for as long as feasible. 

The gross domestic product or GDP is a country's annual market value of products and services.

Economists measure U.S. GDP growth by the rate at which the economy's quarterly production increases or decreases.


The Ideal GDP Growth Rate

Positive GDP growth rates indicate an expanding economy. Rising GDP figures often show business, employment, and personal income growth.

The ideal GDP growth rate is between 2% and 3%. This is the "Goldilocks range" in which economic expansion is not too fast nor too slow.

Beyond 3%, a rapidly growing sector in the economy may develop an asset bubble. This eventually bursts and stalls or contracts economic growth.

A bubble arises when assets such as housing, stocks, or gold experience a rapid price increase unrelated to the product's intrinsic value. 


Note: If the U.S. GDP growth rate spikes over 4% for many years, specific sectors can produce asset bubbles, much like the housing market did years before the 2008 recession.


A negative GDP growth rate can occur when the bubble bursts, placing the nation's economy in a contractionary state or recession. 

During this recession, businesses typically delay making new investments and hiring new employees. Without employment, consumers have less disposable income to buy goods and services, exacerbating the economic downturn.

Negative growth rate tends to persist until the economy reaches a trough, the point at which things begin to turn around. Following the trough, GDP usually begins to rise again.


Note: Two consecutive quarters of falling real GDP usually define a recession.


Why A Healthy GDP Growth Rate Matters


Politicians often think that growth is always better. The truth is that growth becomes good only if it falls within a certain range.

A Stanford University study agrees that GDP growth promotes economic balance within the ideal bounds of 2% and 3%. Development, employment, and inflation are in harmony at this pace, and the economy is healthy.

Outside the ideal range, GDP growth may not be optimal. An economy becomes unhealthy when it expands too slowly or even shrinks.

In contrast, if the economy grows too quickly, it overheats and becomes unsustainable. Demands of consumers, businesses, and the government rise to a point where much of it can't be met.


Remember: An economy that grows too slowly or posts negative growth is unhealthy. It also becomes unsound if it grows too fast, at a rate over the ideal range.


Eventually, natural unemployment rates fall, and prices for goods and services increase. Inflation rises, and the economy swiftly contracts. Unless market forces or the government curb the growth rate, the economy can go into recession.


Note: The Federal Reserve uses monetary policy tools to manage GDP growth, inflation, and economic activity.


When the economy grows too rapidly, the Fed boosts interest rates by increasing the fed fund rates. The Fed reduces rates when the economy contracts. The Fed aims to maintain a 2% inflation rate over the long term.


GDP Growth and The Housing Market in the 2008 Recession

Remember the 2008 recession? It was devastating for many.

A huge explosion of accessible home loans from 2003 to 2006 contributed to the rise of the housing bubble, which began manifesting by the end of 2006.

The bubble burst when the unsustainable demand for homes popped at some point, and home prices started to drop dramatically.

GDP growth rates were disastrous during the 2008 recession. As the crisis permeated the rest of the economy, the housing problems migrated to investors in the financial sector.

Negative GDP growth rates in 2008 affected the entire U.S. economy:

  • Q1 2008: -1.6%
  • Q2 2008: 2.3%
  • Q3 2008: -2.1%
  • Q4 2008: -8.5%

Fortunately, the American Recovery and Reinvestment Act (ARRA) started to swing the economy back to health in March 2009. Yet, recovery was a slow process. Economic growth in the first two quarters of 2009 remained negative before finding a positive footing in the third and fourth quarters of the year.

The repercussions, though, echoed through several years after ARRA. The first and third quarters of 2011 did not post positive growth. The high foreclosure rate of the subprime mortgage crisis prevented the housing market from rebounding. 


What You Can Do As A Home Buyer or Seller


Knowing the real GDP growth rate in the U.S. can help you determine whether the country is experiencing an ideal GDP growth rate or developing asset bubbles in the real estate market and elsewhere. 

As an investor in homes and property, you gain some advantage if you follow the historical prices of the U.S. real estate market. 

You may need to cross-reference this knowledge with the U.S. GDP growth rate or inflation figures. With such data, you may be able to discern rising housing bubbles. These bubbles display such symptoms as increases in real estate interest rates, high levels of debt, surges in home prices, and an escalation in speculative buyers, who typically trigger false demand.

Suppose you don't have a penchant for following economic indicators. In that case, it may be wise to obtain the services of a realtor with a solid knowledge of the U.S. economy. 

Although GDP growth is one of many metrics used to gauge economic health, it is not the only one. Economists also consider the unemployment rate, the consumer price index, and the purchasing manager's index, among others.

A realtor-economist can exponentially increase your chances of making a suitable investment at the right time.

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