Viewpoints

State real GDP growth rates in 2025:Q4 ranged from -8.3% in DC to 3.8% in North Dakota. The plunge in DC was related to the federal shutdown (Maryland also had a marked decline). North Dakota was an outlier on the other side, reflecting a pickup farm output. Most states had sluggish growth rates within a point of the nation’s .5%.

Personal income growth rates ranged from -4.0% in North Dakota to Hawaii’s astronomical 41.5%. Hawaii’s gain was the result of a large settlement payment related to the 2023 Maui wildfire. North Dakota’s loss stemmed from a sharp drop in earnings (compensation plus proprietors’ income). Most states saw gains trailing the national growth rate of 3.4%; with the exception of California the larger states typically saw higher growth rates.

On February 28 the US and Israel launched airstrikes on Iran. In retaliation, Iran closed the Straits of Hormuz. By early April the average US price of regular gasoline jumped to $4.11/gallon from $2.93/gallon in February, an increase of 40%.

To put this price shock in historical perspective, I: defined the real price of gasoline as the price index for personal consumption expenditures (PCE) on gasoline (and other motor fuels) over the price index for total PCE; calculated monthly percent changes in this real price of gasoline; weighted each of those changes by the geometric average of the current and lagged monthly shares of nominal gasoline purchases in total nominal PCE; cumulated the weighted price changes from January of 1960 to the present.

On balance, state labor markets were fairly stable in January. Several states had statistically significant gains in payrolls, led by California’s 93,500 (.5 percent) surge. In other large states Texas was up 40,100 and Illinois 18,000-both increases of .3 percent. DC was the only significant drop; down 5,400 (.7 percent). Most other states had insignificant gains (these amounted to more than 20,000 in Florida and New York). As one might expect, most of the DC job loss was in government.

The only state to experience a statistically significant change in its unemployment rate was Florida, which saw a .2 percentage point gain. The highest unemployment rates were in DC (6.7%), California (5.4%), Delaware (5.4%), Nevada (5.3%), New Jersey (5.2%), Oregon (5.2%), Michigan (5.0%), and Washington (5.0%). Alabama, Hawaii, North Dakota, South Dakota, and Vermont had unemployment rates below 3.0%, with Hawaii and South Dakota’s the lowest, both at 2.2%.

Puerto Rico’s unemployment rate was unchanged at 5.7% and the island’s job count edged down 400.

We remain overweight Japanese equities and view the recent market correction as a buying opportunity. The macro backdrop remains constructive: business cycle indicators are firm, corporate profitability is strong, and there are no major systemic risks. Any economic slowdown is likely to be temporary and should be looked through rather than feared.

Business cycle signals reinforce this view (Figure 1). Profit and investment cycles are clearly in an upswing, while borrowing costs remain well contained. The two-year real lending rate, though rising, sits comfortably within its historical range, indicating that the cost of capital is not restrictive. Credit growth is broadly aligned with economic expansion, with signs of strengthening private sector demand. The only soft spot is money supply growth, but even here the recent acceleration reflects a rebound from low levels rather than a structural concern. Overall, the Bank of Japan (BoJ) expects real GDP growth of around 1% annually over the next three years—well above its estimated potential rate of 0.5%.

The US economy is currently facing a major energy shock, and the Federal Reserve needs to apply strategies designed for supply shocks. Yet, the Federal Reserve appears to be operating under the belief that they are still dealing with the long-term impacts of a demand shock. The projections from the March 17-18 Federal Open Market Committee meeting suggest a long-term forecast of official rates at 3% and inflation at 2%, resulting in a real official interest rate of 1%. In today's world, that projected rate is much too low.

Although demand and supply shocks may share characteristics like job losses and wealth destruction, the primary distinction lies in their impact on inflation. Demand shocks generally result in a significant drop in inflation, whereas supply shocks have the opposite impact, leading to price hikes from production through to distribution and retail, which in turn causes both headline consumer inflation and core inflation to rise.

Before the two demand shocks of the early 2000s (the tech bubble and financial crisis), the Fed maintained a real longer-run official rate of 2%, sometimes reaching as high as 3%. Following the demand shocks, particularly the financial crisis, the Fed maintained very low and even negative real official rates, after factoring in the stimulative impacts of the quantitative easing policy.

However, those economic conditions are now a thing of the past. Currently, with core inflaiton at 3% and managing with a nominal official rate in the low mid-3% range during the initial phases of an energy shock, it places monetary policy in a precarious situation, as it increases the risk of prolonged higher inflation. Policymakers aim to avoid the policy errors made after the COVID supply shock, but the political climate might leave them with no alternative.

Therefore, it should come as no surprise that the bond market is sensing more inflation.

The Middle East crisis and the limits of the global economy

For three decades, macroeconomics has leaned on a simple idea: that demand management can stabilise the system. In reality, that framework has been fraying for years. The latest escalation in the Middle East doesn’t just reinforce the point—it sharpens it. This is not another cyclical shock, but a reminder that the global economy is increasingly governed by supply-side constraints that policy cannot easily offset.

Even with tentative signs of de-escalation emerging this week, the episode has brought into much sharper focus a theme I have been returning to repeatedly: the global economy is no longer primarily demand-constrained. It is increasingly shaped—and at times paralysed—by supply-side limits.

Let’s look at some data related to US equities first. Plotted in Chart 1 are the end-of-year values of directly-held equities held by households at market value as a percent of households’ total assets at market value. At the end of 2025, this percentage was 22.95, a post-World War II record high.

In early 2025 the Trump Administration announced a base tariff of 10% on imported goods, additional steep “reciprocal tariffs” on goods imported from countries running large trade surpluses with the United States, and additional levies on specific imported commodities. The average tariff rate on all imports surged from approximately 2.5% to 10%. The increase would have been larger if not for the many “slips twixt cup and (dutiable) lip.” Indeed, it might surprise many that today only 40% of imported goods are subject to tariffs (Chart 1).