Tariffs are a self-inflicted economic catastrophe for the US
Risks of recession have just gone up, while the standard of living could go down.
The tariff hikes announced April 2, if maintained, represent a self-inflicted economic catastrophe for the US.
We haven’t yet published a full update, but we’ll likely be reducing our US real GDP growth forecast for 2025 and 2026 by around 0.5 percentage point each. The upward impact on inflation will likely be of a similar magnitude. But the impact on inflation and monetary policy is highly contingent on other factors.
Recession risk has vaulted up. But a recession can be purely short-run pain. If the tariffs hikes are maintained, they will permanently reduce US real gross domestic product, and hence real living standards for the average American.
The announced tariffs far exceed what we had incorporated into our last published economic forecast. Of course, only the tariffs that stick around really matter. But—contrasting with what we saw with Canada and Mexico a month ago—we see little reason to expect quick alleviation of these tariff hikes. They might be whittled down a bit, but there’s no clear path to removing the bulk of them.
Previously, we had seen tariff threats as largely a means to push through various geopolitical goals, as had been the case in President Donald Trump’s first administration. The first few months of his second term seemed to conform to this—tariffs were implemented on Canada and Mexico for a few days but then quickly rescinded after he said concessions were made around border security and other issues.
But on April 2, Trump’s rhetoric was purely mercantilist. He is determined to use tariffs to quash the US trade deficit and thereby revive US manufacturing dominance to its historical heights. As he reminded us, he’s harbored this vision since the 1980s. In contrast to the first Trump administration, he’s now surrounded by personnel who bow to this vision. Thus, we now think tariffs are here for the long haul.
The tariffs unveiled April 2, combined with other recent announcements, could represent an increase in the average tariff rate by around 25%. That would take the average US tariff rate to around 27%, the highest in over 100 years.
The impact on inflation and monetary policy, along with the impact on short-run GDP (distinct from long-run GDP) will depend on a slew of other factors.
Namely, will the tariff revenue be recycled as tax cuts? This wouldn’t mitigate the deleterious impact on economic efficiency (and hence long-run GDP), but it would reduce the demand-side hit, thereby reducing recession risk.
Uncertainty among businesses and consumers is reaching a fever pitch, which will weigh on spending independently of the direct impact of the tariffs. Because of that, the contraction in demand could actually exceed the disruption to supply (in the short run), making the tariff shock more recessionary than inflationary.
On the flip side, if all of the tariff revenue is used for new tax cuts, that would be much more inflationary, given the demand side of the economy would be better supported.
In terms of monetary policy, tariff hikes without more tax cuts, and with uncertainty suppressing spending, would all call for more interest-rate cuts compared with the baseline. But if the tariff shock is more inflationary, then the Fed could be forced to put rate cuts on hold for an extended period.
