[New Year Interview ①] "AI-Driven Stock Market Correction Is the Biggest Risk for the U.S. Economy in 2026... A 15-20% Drop Could Trigger a Recession"

AI Optimism Drives U.S. Economic Growth
K-Shaped Consumption Structure Vulnerable to Market Correction
Tariff-Induced Inflation and Reduced Immigration Weigh on Economy
Rising Debt Risks Fuel Concerns Over Financial Instability
Fed Likely to Ease Policy; Independence Remains Paramount

"The greatest risk for the U.S. economy in 2026 is the possibility that the asset market, buoyed by expectations surrounding artificial intelligence (AI), could enter a correction phase. If the stock market falls by 15 to 20 percent, consumption could stagnate, potentially leading to a mild but clear economic recession."

Karen Dynan, Professor of Economics at Harvard University, is conducting a video interview with The Asia Business Daily on the topic of the U.S. economic outlook for 2026. New York?Photo by Kwon Haeyoung

Karen Dynan, Professor of Economics at Harvard University (photo), issued this warning in a recent New Year's interview with The Asia Business Daily, saying that the U.S. economy, which has been driven by optimism about AI, may face a turning point in 2026.

Professor Dynan is a leading U.S. macroeconomist who served as Assistant Secretary for Economic Policy at the Treasury Department under the Barack Obama administration, and has worked as an economist for the White House Council of Economic Advisers and the International Monetary Fund (IMF).

She observed, "The recent U.S. economy has been heavily dependent on the wealth effect stemming from increased AI investment and rising stock markets." While optimistic about AI's medium- to long-term potential, she cautioned that, in the short term, there is a risk that expectations may outpace actual results. If this foundation is shaken, both consumption and growth could slow.

In particular, she identified the structure in which consumption-accounting for about two-thirds of the U.S. economy-has become excessively reliant on the stock market as the most vulnerable link. While high inflation has constrained spending among lower-income groups, the wealth effect among higher-income households is propping up overall consumption, creating a 'K-shaped consumption' structure. She expressed concern that a stock market correction could transmit shocks to the real economy.

She noted that the severity of the shock from an asset market correction could vary depending on where risks are accumulating within the financial system. Professor Dynan said, "If the banking system remains relatively sound, the correction is likely to result in only a mild recession. However, the very fact that it is difficult to pinpoint exactly where the risks lie is itself a source of uncertainty."

She cited the following as major downside factors for the U.S. economy in 2026: a reduction in labor supply due to decreased immigration, the lagged effects of tariff-induced inflation, and uncertainty in economic policy. However, she emphasized that a recession is not the most likely base scenario.

Additionally, Professor Dynan expressed concern that the federal government's fiscal deficit and debt levels have "entered an abnormally high stage." She pointed out that the accumulation of debt could lead to higher long-term interest rates and crowd out private investment, undermining growth potential over the medium to long term. She warned, "Even small events, such as political clashes over the debt ceiling or policy missteps, could amplify financial market instability. With so much dry tinder already in place, even a single spark could trigger a crisis."

The following is a Q&A with Professor Dynan.

-Despite concerns about a recession, the U.S. economy remained robust in 2025. How do you assess this?

▲The U.S. economy in 2025 was much stronger than expected. The main driver was strong optimism about AI. Companies ramped up AI investments, and profits from rising stock markets translated into increased consumption, which in turn propelled the economy. The expectation of deregulation and tax cuts following the launch of the second Trump administration also positively supported business sentiment.

-What is your overall outlook for the U.S. economy in 2026?

▲In 2026, growth is likely to slow somewhat. While some momentum from AI investment and the stock market will persist, reduced immigration, inflation and purchasing power constraints caused by tariffs, and policy uncertainty will increasingly weigh on the economy. The risk of a recession exists, but it is not the base scenario.

-Could you provide specific forecasts for economic growth, inflation, and the labor market?

▲Growth in 2026 could slow to around 1.5 percent. Inflation could rise to 3 to 3.5 percent in the first half of the year and is expected to slightly exceed 3 percent on an annual basis. The inflationary impact of tariffs has been delayed due to political pressure and companies' preemptive import expansion, but it is highly likely that companies that have postponed price increases will implement them all at once at some point. The labor market has cooled compared to two years ago, but back then it was excessively overheated, fueling inflation. Currently, there are no signs of a sharp further deterioration. Although reduced immigration is decreasing labor supply, even if companies want to cut jobs, the likelihood of a sharp rise in unemployment is limited.

-What is the biggest variable and risk factor for the U.S. economy in 2026?

▲Asset market correction. If expectations for AI's short-term profitability turn to disappointment, a stock market correction could occur. If the stock market falls by 15 to 20 percent, consumption will stagnate for a significant period. The bigger problem is the deterioration of consumer sentiment, rather than the decline in asset values themselves. If such shocks accumulate, they could lead to a mild recession.

-What impact will the second Trump administration's tax cuts and the 'tariff dividend' plan have on the U.S. economy?

▲The overall growth effect of the tax cut bill is likely to be limited. While some measures, such as exempting tip income from taxes, may help lower-income groups, tax cuts focused on higher-income groups have little effect on boosting consumption. The bigger problem is the fiscal deficit and rising debt caused by the tax cuts. The plan to pay out a tariff dividend of $2,000 per person conflicts with the goal of curbing inflation.

-How do you assess the current federal fiscal deficit and debt problem?

▲At the moment, it may appear that there is no major shock to the economy, but the constraints will grow over time. As debt accumulates, the government's fiscal options become more limited, making it increasingly difficult to pursue policies that support growth. The biggest issue is when a financial crisis will occur. We must be wary of the possibility that any policy announcement or political clash over the debt ceiling could combine with financial market instability. While it is impossible to predict the exact timing, it is clear that the higher the debt-to-GDP ratio, the greater the probability of a crisis.

-What is your outlook for the Federal Reserve's interest rate path and the dollar's trajectory?

▲Since the Fed is most concerned about being perceived as causing a recession, it is likely to maintain a somewhat dovish (accommodative) stance. Accordingly, in 2026, there is a high likelihood that the Fed will cut rates at least once (by 0.25 percentage points). If inflationary pressures rise again due to tariffs, further adjustments after one cut may be limited. Unless the economy contracts sharply, it is unlikely that the current policy rate of 3.5 to 3.75 percent per year will fall below 3 percent per year.

As for the dollar, if the U.S. economy grows at a rate of 1 to 1.5 percent, it is likely to remain at roughly current levels. However, as the risk of a growth slowdown has increased, the possibility of a weaker dollar is higher than it was a year ago.

-What is your view on recent concerns about threats to the Fed's independence?

▲The Fed's independence is of utmost importance. The reason inflation was able to stabilize relatively quickly in the early 2020s was the market's confidence that the Fed would ultimately bring inflation back down. If a new Fed chair is appointed who is perceived as being under presidential control, the situation could change. Expected inflation could rise, and this is the most dangerous scenario.

Professor Karen Dynan
Professor Karen Dynan is a leading U.S. expert in macroeconomics and fiscal policy. From 2014 to 2017, she served as Assistant Secretary for Economic Policy and Chief Economist at the U.S. Treasury Department under the Barack Obama administration, and has worked as an economist for the White House Council of Economic Advisers (CEA) and the International Monetary Fund (IMF). From 2009 to 2013, she was Vice President at the Brookings Institution. She is currently a Professor of Economics and Professor at the Kennedy School at Harvard University, and a Senior Fellow at the Peterson Institute for International Economics (PIIE). She holds a bachelor's degree in economics from Brown University and a master's and Ph.D. in economics from Harvard University.