Viewpoints

In recent months, I’ve been exploring how deep structural constraints—on labour, capital, and above all, energy—are reshaping the world economy. What’s become increasingly clear is that we’re moving away from the familiar rhythm of demand-led recoveries and into something more constrained, more structural. Growth isn’t just slow—it’s bumping up against hard supply-side ceilings. Some of those were pandemic-induced. Others were physical. Many, increasingly, are ecological.

Arguably at the heart of that shift is energy. Not as an afterthought or cost input, but as a binding constraint. As I’ve written before, energy isn’t just another factor of production. It’s the factor that makes all other inputs productive. Without energy, capital is idle, and labour is inert. But to understand the full extent of this transformation—and where it’s leading—we need to look beyond energy itself, to the natural systems that support it.

State labor markets were very little changed in May. No state reported a statistically significant change in jobs. Three states (Iowa, Massachusetts, and Virginia) had statistically significant increases in their unemployment rates, while two (Indiana and New York) had statistically significant declines. None of these moves were larger than .2 percentage points. The highest unemployment rates were in DC (5.9%), Nevada (5.5%), Michigan (5.4%), California (5.3%), and Kentucky (5.0%), though Kentucky’s rate is not deemed statistically different than the national average of 4.2%. Hawaii, Montana, North Dakota, South Dakota, and Vermont had unemployment rates under 3.0%, while South Dakota’s 1.8% was yet again the lowest in the nation.

Puerto Rico’s unemployment rate was unchanged at 5.5% and the island’s job count moved up by 2,000.

The Fed just released its latest quarterly report on the balance sheet of households and nonprofit organizations, and the stunning magnitude of household net worth is one reason why consumer spending has remained resilient. Household net worth dipped modestly in 2025Q1 with the stock market correction, but remains staggeringly high, and with the stock market recovery and continued rise in residential home values, it likely will rise to another record high in Q2. Amid uncertain times, it continues to support consumer spending.

Real (inflation-adjusted) disposable personal income is the primary driver of consumption. Most households spend the vast majority of their DPI and save a small portion. Wage and salaries, the driving force of DPI, have benefited by increasing real wages and continued growth of employment. DPI has risen 36% since pre-Covid, materially faster than the cumulative 34% rise in the CPI.

Changes in household net worth--the value of real estate and financial assets, net of all debt--affect the propensity to spend disposable income. Increases in household net worth increase the propensity to spend disposable income (and reduce the rate of personal saving) while marked declines in household net worth lead households to more (spend less) and replenish their wealth. Workers who lose their jobs or incur losses in income draw down their savings to smooth their consumption, while others (particularly older people) "dissave" and spend on an array of goods and a lot of services.

A one (1) percentage point change in the rate of personal saving can have dramatic impact on the rate of growth of consumption, resulting in “sluggish” or “robust” consumption. The increases in household net worth in recent years has raised consumption and reduced the rate of personal saving, just the opposite of the years following the Great Financial Crisis, when households saved a higher portion of their DPI in response to the sharp declines in households’ financial wealth and the value of real estate (Chart 1). That period followed the pre-GFC period of soaring home prices and stock market, which fueled strong growth in consumption and low rates of saving.

The stunning magnitude of household net worth in the Fed’s quarterly report on the balance sheet of households and nonprofit organizations is one reason why consumer spending has remained resilient. Household net worth dipped modestly in 2025Q1, but remains staggeringly high, and with the recovery of the stock market and continued rise in residential home values, it likely will rise to another record high in Q2.

Before the 2024 presidential election my uncontroversial view of the near-term economic outlook was that real GP would grow near 2% for the next few years with the economy remaining near full employment, inflation subsiding towards 2%, and the Fed gradually cutting its policy rate. I assumed the personal provisions of the Tax Cuts and Jobs Act (TCJA) would be extended beyond 2025, and that both the limitations on state and local tax (SALT) deductions and the temporary business provisions in TCJA would sunset as scheduled under current law.

Now Congress is debating the One Big Beautiful Bill Act (OBBBA) while courts decide the legality of new tariffs imposed by the Trump Administration. Here I offer thoughts on how, directionally, these policies, if enacted, would shift my view of the near-term outlook for real GDP growth. To organize my discussion, I’ll group the policies like this:
• OBBBA o Extend TCJA o New tax cuts o New tax increases o Increased spending by the Department of Homeland Security o Spending cuts, including Medicaid • New tariffs

Let’s begin by asking how much failure to extend TCJA might undermine near-term growth. I’m skeptical of estimates suggesting the impact to be large but, given limitations here on space, a picture is worth thousands of words. The nearby chart shows annual real GDP growth from 2011 through 2024, including the first two years (2018 and 2019) when TCJA was in effect, but before COVID punctuated the near-term outlook. Then, like today, the economy was near full employment with inflation near the Fed’s 2% target. I don’t see a significant pickup in growth during those two years even though, as its centerpiece, TCJA cut the corporate tax rate to 21% permanently. Perhaps not all ceteris are paribus here, but would I expect failure to extend the other provisions of TCJA to have a big negative impact on near-term growth? No and in any event, as mentioned above, I expected the personal provisions of TCJA to be extended.

To help finance the reduction in the corporate tax rate, TCJA made other business tax cuts temporary and also included subsequent business tax increases. For example, under current law “bonus depreciation,” which has fallen from 100% in 2018 to 30% in 2025, ends next year. Limitations on deductions for interest and depreciation of R&D expenditures were implemented in 2022 and 2024. Here OBBBA would not extend current policy but rather would revive the initial TCJA provisions for five years. It also makes the TCJA treatment of certain foreign earnings permanent. I’d not assumed these “extensions” of the business provisions of TCJA, so I consider them new tax breaks that would boost my forecast.

When the Balances Stop Balancing

In the global economy, nothing ever balances itself — it must be balanced. And the tool we use to understand that process is the financial balances identity:

(Private Sector Balance) + (Government Balance) + (Current Account Balance) = 0

This deceptively simple equation reminds us that the financial positions of households, businesses, governments, and the rest of the world are always interlinked — one sector’s deficit must be matched by a surplus elsewhere. But when policies distort trade and capital flows, they don’t eliminate this identity. They just shift the burden of adjustment — often suddenly and painfully — to another part of the system.

We’re now entering such a phase. As we explored in a previous piece (see the bond market and productivity), the global economy is confronting overlapping questions about how — and where — capital will be absorbed. That blog argued that it’s not simply a question of whether savings adjust (they must), but rather what mix of prices, policies, and expectations will force that adjustment — particularly as governments and firms simultaneously reach for the same pool of private capital to fund deficits and an AI-driven capex surge.

These concerns sit at the heart of what this next piece explores. Around the world, governments are pulling financial levers in conflicting directions. The United States is simultaneously contemplating financial transaction taxes, introducing punitive investment measures, and expanding fiscal deficits. Europe is loosening its purse strings in the name of strategic autonomy, while fast-tracking plans for a Savings and Investment Union that would re-anchor more capital within its borders. And China, still deeply mercantilist, is doubling down on export-led growth, capital controls, and state-directed investment — while keeping domestic consumption artificially suppressed.

Overlaying all this is a sharp resurgence in protectionist trade policy, with the United States now imposing tariffs across a wide swathe of imports. These frictions are not just policy noise — they are tearing at the global capital recycling mechanisms that once allowed persistent imbalances to be absorbed without systemic rupture.

As we wrote last time, markets may be pricing in an AI-led productivity renaissance — but if that narrative falters or is undercut by misaligned financial flows, the repricing could be swift and severe. And here’s the real concern: the fragile scaffolding that once allowed the world to function with these imbalances is now being dismantled — leaving a system where capital is needed in one place, unwanted in another, and increasingly blocked from flowing freely.

The United States Closes the Financial Tap

Suppose the US implements a tax on financial transactions or introduces new restrictions on foreign portfolio investment. This would mark a sharp reversal from decades of financial openness, fundamentally challenging the US model of attracting global capital to fund persistent fiscal and current account deficits.

Recent policy proposals, including those under the so-called "Big Beautiful Budget" clause and Section 899 of the Internal Revenue Code, point to a new willingness to weaponize financial channels. Section 899 allows for punitive taxation—so-called "revenge taxes"—on investors from countries deemed to have imposed discriminatory measures against the US. These steps create uncertainty for foreign capital and increase the risk premium on US assets.

If capital inflows shrink, the identity demands that either: • The current account deficit shrinks (via export gains or import compression), • The government deficit shrinks (unlikely given current policy), or • The private sector saves more than it invests.

This would strain the US economy. The dollar would likely weaken. Treasuries might lose some of their safe haven appeal, especially if yields rise to compensate for reduced foreign demand. Liquidity premia would widen. The US could no longer rely on the rest of the world to finance its deficits cheaply and reliably.

US Fiscal Expansion Without Financing

Now consider a parallel development: a renewed US fiscal expansion driven by tax cuts and defence spending. The federal deficit widens further. But with capital inflows potentially constrained, the private sector—households and corporations—must absorb the gap.

This creates a contradiction. Expansionary fiscal policy often tends to reduce household saving (more income, more consumption) and encourages firms to invest. But the financial balances identity demands the opposite: that the private sector save more to offset government dissaving and a flat or shrinking current account.

If private savings don’t rise, interest rates must. The result: pressure on equity and bond markets, and a risk that the US enters a cycle of high borrowing costs just as its productive potential hinges on long-term investment.

Vietnam’s economy has made impressive strides and is now nearly a third larger than it was on the eve of the pandemic. In 2024, it grew just above its potential rate—7% versus a 10-year pre-pandemic average of 6.5% per annum. That said, the best may be behind it. In Q1 2025, growth moderated to 6.9% year-on-year, down from 7.6%, with consumption, investment, exports, and imports—an important lead indicator of domestic demand—all softening.

Milton Friedman taught us that when it comes to evaluating the stance of monetary policy, look at monetary quantities, not the level of interest rates. A given level of federal funds rate can represent a tight monetary policy if the demand for credit is weak. In this case we would expect to see a relatively low rate of growth in bank credit. Similarly, that same level of the federal funds rate can represent an easy monetary policy if the demand for credit is strong. In this case we would expect to see a relatively high rate of growth in bank credit.

The federal funds rate has been at a level of 4.33% since December 25, 2024. Yet, as can be seen in the chart below, growth in bank credit has increased significantly. In the 13 weeks ended May 21, 2025, the annualized growth in bank credit was 7.9%, the highest since mid-August 2022. Adjusted for consumer inflation, today’s 7.9% growth in bank credit is higher than it was in August 2022.

The Federal Reserve Bank of Philadelphia’s state coincident indexes in April were rather soft. In the one-month changes, Nevada’s fairly modest .55 percent increase was the largest, with Indiana the only other state with a gain higher than .5 percent. 12 states showed declines; all except Arkansas were in the Northeast and Middle West. Massachusetts had the largest decline (.47 percent). Over the three months ending in April seven states were down (again, all except Arkansas in the Northeast and Middle West), with Massachusetts on the bottom (down .67 percent) here as well. West Virginia’s 1.54 percent was the largest gain, while 9 other states had increases above 1 percent. Over the last twelve months, Iowa and Michigan were down, and eight others saw increases of less than one percent. No state had an increase higher than four percent (Utah was up 3.55 percent), and only three were at or higher than three percent.

The independently estimated national estimates of growth over the last three and twelve months were, respectively, .46 and 2.34 percent. Both measures appear to be a bit weaker than the state numbers would have suggested.