[New Year Interview ①] "U.S. Economy Driven by AI Optimism... A 15-20% Market Correction Could Trigger a Recession"

AI Optimism Drives U.S. Economic Growth
K-Shaped Consumption Structure Vulnerable to Market Corrections
Tariff-Driven Inflation and Reduced Immigration Add Pressure
Rising Debt Risks Heighten Financial Instability Concerns
Fed Likely t

"The biggest risk to the U.S. economy in 2026 is the possibility that the asset market, which has been buoyed by expectations for artificial intelligence (AI), may 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 during a recent New Year's interview with The Asia Business Daily, stating that the U.S. economy, which has been driven by AI optimism, could reach a turning point in 2026.

Professor Dynan is one of America's leading macroeconomic experts, having served as Assistant Secretary for Economic Policy at the U.S. Treasury during the Barack Obama administration, as well as working as an economist at the White House Council of Economic Advisers and the International Monetary Fund (IMF).

She diagnosed that "the recent U.S. economy has been heavily dependent on the wealth effect stemming from increased AI investment and a rising stock market." While she remains optimistic about AI's medium- to long-term potential, she warned that in the short term, expectations may outpace actual results, and if this pillar is shaken, both consumption and growth could slow down.

In particular, she pointed out that the most vulnerable link is the structure in which consumption, which accounts for about two-thirds of the U.S. economy, has recently become excessively dependent on the stock market. While high inflation has constrained spending among lower-income households, the wealth effect among higher-income groups has been supporting 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 intensity 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 is relatively healthy, the correction is likely to result in only a mild recession, but the very fact that it is difficult to pinpoint the location of risks adds to the uncertainty."

She identified the following as the main downside risks for the U.S. economy in 2026: a reduction in immigration leading to a smaller labor force; the lagged effects of tariff-induced inflation; and economic policy uncertainty. However, she clarified that a recession is not the most likely baseline 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 in the medium to long term. She warned, "Even small events, such as political clashes over the debt ceiling or policy mistakes, could amplify instability in financial markets. When dry tinder is already piled up, 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 performed solidly in 2025. How would you assess this?

▲The U.S. economy in 2025 was much stronger than expected. The key driver was strong optimism about AI. Companies expanded their AI investments, and the gains from the rising stock market translated into increased consumption, which in turn drove the economy. The anticipation of deregulation and tax cuts following the launch of the second Trump administration also supported business sentiment, which was a positive factor.

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

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

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

▲The growth rate in 2026 is likely to slow to around 1.5 percent. Inflation could rise to the 3 to 3.5 percent range 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 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 at that time it was excessively overheated and fueling inflation. For now, there are no signs of a sharp further deterioration. Even if companies want to cut jobs due to reduced labor supply from lower immigration, the likelihood of a sharp spike in the unemployment rate is limited.

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

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

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

▲The overall growth effect of the tax cut bill is likely to be limited. While measures such as making tip income tax-exempt will help lower-income households to some extent, tax cuts focused on higher-income groups will not have a significant effect on boosting consumption. The bigger problem is the fiscal deficit and rising debt resulting from the tax cuts. Providing a tariff dividend of $2,000 per person is at odds with the goal of curbing inflation.

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

▲At present, it may seem that there is no major shock to the economy, but over time the constraints will grow. As debt accumulates, the government's fiscal options will narrow, making it increasingly difficult to pursue policies that support growth. The biggest problem is the timing of a potential financial crisis. We need to 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 as the debt-to-GDP ratio rises, the probability of a crisis increases.

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

▲The Federal Reserve is likely to maintain a somewhat dovish stance, as it is most wary of being seen as having caused a recession. Accordingly, there is a high possibility that the Fed will cut rates at least once in 2026 (by 0.25 percentage points each time). 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 will fall below 3 percent per year.

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

-How do you view the recent concerns about the erosion of the Fed's independence?

▲The independence of the Federal Reserve is paramount. The reason inflation was able to stabilize relatively quickly in the early 2020s was because the market trusted that the Fed would ultimately bring inflation back down. If a new Fed chair perceived to be under presidential control is appointed, the situation could change. Expected inflation could rise, and that is the most dangerous scenario.

Who is Professor Karen Dynan?
Professor Karen Dynan is a leading U.S. expert on macroeconomics and fiscal policy. From 2014 to 2017, she served as Assistant Secretary for Economic Policy and Chief Economist at the U.S. Treasury during the Barack Obama administration, and has worked as an economist at the White House Council of Economic Advisers (CEA) and the International Monetary Fund (IMF). From 2009 to 2013, she was Vice President of the Brookings Institution. She is currently a professor in the Department of Economics and 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 master's and doctoral degrees in economics from Harvard University.