Should you be smiling or frowning about 2026?

It’s that time of year for economists to emerge and present their economic forecasts. Some say it’s like the economic version of groundhog day.  Will economists see the light of a good year ahead or the clouds of a dreary time in our future?

I’ve joined the economic groundhog day celebration for almost fifty years.  But beware.  Just because I and my colleagues have a Ph.D. behind our names doesn’t’ mean we are infallible in our predictions. In fact, in many cases our success rate in our predictions is very low. Still, our forecasts may be useful if they point to factors driving the economy we should watch in 2026. 

But before I jump into 2026, let me give a short summary of the 2025 economy. I give the 2025 economy either a C+ of B – grade, meaning borderline good.  On the plus side the economy grew – meaning there was no recession – jobs were added, and the inflation rate was near 2% in the early part of the year.  A 2% inflation rate is near the low point when the economy is prospering.  Lower and negative inflation rates – meaning prices are falling – typically occur when the economy is  bad, such as in a recession or depression.

Perhaps the best economic news for households in early 2025 was that many saw their work earnings rise faster than inflation.  This means they were able to claw back some of their standard of living lost when the inflation rate was at double-digit rates in earlier years.

 But the second half of 2025 was a different story. The job market slowed, including some announced layoffs at major employers.  The jobless rate rose in the nation, but remained relatively stable in North Caolina. Importantly, the average change in prices – inflation – accelerated, rising from near 2% early in the year to near 3% later in the year. As a result, households’ gains in their standard of living stalled, and for some, declined.

There was one good piece of news that carried over from early 2025 to late 2025 for home buyers.  Mortgage interest rates dropped throughout 2025, with 30-year fixed mortgage rates falling three-quarters of a percentage point.

So which economy, the good of early 2025 or the not-as-good of late 2025, will prevail in 2026?

The challenge is we are entering 2026 with a large amount of uncertainty, and businesses and investors don’t like uncertainty because it makes it more difficult for them to plan and anticipate the future.  We have uncertainly over Federal Reserve policy.  Will the “Fed” cut their interest rates, hold rates steady, or even raise rates?  What will happen with tariffs?  Tariffs are important because many economists blame them for the acceleration of inflation in the second half of 2025.  It’s important to remember that tariffs are paid by US importing companies and not by the foreign exporting companies.  It appears US companies initially absorbed the cost of tariffs early in 2025, but then began to pass those costs on to buyers by raising prices later in 2025.

Now I will develop forecasts for 2026 based on scenarios for the uncertain factors, and I’ll begin with the Federal Reserve.  After World War II, Congress added two mandates to the Fed’s responsibilities - keep the inflation rate low, and keep the unemployment rate low. If the Fed uses its tools to focus on lower unemployment, this means cutting interest rates and creating more money. The Fed does the opposite if their focus is to lower inflation. During 2025 it appears the Fed was more concerned with jobs than with inflation.  Assuming this concern is maintained in 2026 indicates slightly lower interest rates.  Also, Fed Chairperson Jay Powell’s term as Chair ends in May, and President Trump will likely appoint a replacement who supports lower rates.  Although the Fed Chair has only one vote among twelve, in rate decisions the new Chair will likely advocate for lower rates.

The “big beautiful bill” passed by the federal government in 2024 has numerous provisions that will take effect in 2026. Among them are several reducing taxes for both households and businesses. The likely result is more investment, more production, and more jobs resulting in higher incomes for households but with no adverse impacts on inflation.

Last, if tariffs are relaxed or completely removed, the impact should be a reduction in the inflation rate.  Prices will still be rising, but at a slower rate, therefore setting up a situation allowing more households to see their earnings increase faster than prices.   

Hence, I’m cautiously optimistic about the 2026 economy, giving it a B grade. Still, there are many “ifs,” even for economists, meaning we all have to decide.

I should add that forecasts for inflation, interest rates, and impacts of federal tax changes apply to North Carolina just as in the nation.   But in terms of business expansion, job growth, and economic opportunities, North Carolina will likely continue to come out ahead of the nation in 2026, just as it has in previous years. In terms of the economy, companies and investors have “Carolina on My Mind.”

Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.