Amid trade tensions and high policy uncertainty, the path forward will be determined by how challenges are confronted and opportunities embraced, says the IMF

By Pierre-Olivier Gourinchas

The global economic system under which most countries have operated for the last 80 years is being reset, ushering the world into a new era. Existing rules are challenged while new ones are yet to emerge. Since late January, a flurry of tariff announcements by the United States, which started with Canada, China, Mexico and critical sectors, culminated with near universal levies on April 2. The US effective tariff rate surged past levels reached during the Great Depression while counter-responses from major trading partners significantly pushed up the global rate.

The resulting epistemic uncertainty and policy unpredictability is a major driver of the economic outlook. If sustained, this abrupt increase in tariffs and attendant uncertainty will significantly slow global growth. Reflecting the complexity and fluidity of the moment, our report presents a range of forecasts for the global economy.

Our World Economic Outlook’s reference forecast includes tariff announcements between February 1 and April 4 by the US and countermeasures by other countries. This reduces our global growth forecast to 2.8 percent and 3 percent this year and next, a cumulative downgrade of about 0.8 percentage point relative to our January 2025 WEO update. We also present a global forecast excluding the April tariffs (pre-April 2 forecast). Under this alternative path, global growth would have seen only a modest cumulative downgrade of 0.2 percentage point, to 3.2 percent for 2025 and 2026.

Finally, we include a model-based forecast incorporating announcements made after April 4. Over that period, the United States temporarily halted most tariffs while raising those on China to prohibitive levels. This pause, even if extended indefinitely, does not materially change the global outlook compared to the reference forecast. This is because the overall effective tariff rate of the United States and China remains elevated even if some initially highly tariffed countries will now benefit, while policy-induced uncertainty has not declined.

Despite the slowdown, global growth remains well above recession levels. Global inflation is revised up by about 0.1 percentage point for each year, yet the disinflation momentum continues. Global trade was quite resilient until now, partly because businesses were able to re-route trade flows when needed. This may become more difficult this time around. We project that global trade growth will dip more than output, to 1.7 percent in 2025—a significant downward revision since our January 2025 WEO Update.

However, the global estimate masks substantial variation across countries. Tariffs constitute a negative supply shock for the implementing jurisdiction, as resources are reallocated towards the production of less-competitive items with a resulting loss of aggregate productivity and higher production prices. In the medium term, we can expect tariffs to decrease competition and innovation and increase rent-seeking, further weighing on the outlook.

In the United States, demand was already softening before the recent policy announcements, reflecting greater policy uncertainty. Under our April 2 reference forecast, we have lowered our US growth estimate for this year to 1.8 percent. That’s 0.9 percentage point lower than January, and tariffs account for 0.4 percentage point of that reduction. We also raised our US inflation forecast by about 1 percentage point, up from 2 percent.

For trading partners, tariffs are mostly a negative demand shock, driving foreign customers away from their products, even if some countries can benefit from the trade diversion. Consistent with this deflationary impulse, we have lowered our China growth forecast for this year to 4 percent, a 0.6 percentage point reduction, and inflation is revised down by about 0.8 percentage point.

Growth in the euro area, which is subject to relatively lower effective tariffs, is revised down by 0.2 percentage point, to 0.8 percent. Both in the euro area and China, stronger fiscal stimulus will provide some support this year and next. Many emerging market economies could face significant slowdowns depending on where tariffs settle. We have lowered our growth forecast for the group by 0.5 percentage point, to 3.7 percent.

Dense global supply chains can magnify the effects of tariffs and uncertainty. Most traded goods are intermediate inputs that cross borders multiple times before being turned into final products. Disruptions can propagate up and down the global input-output network with potentially large multiplier effects, as we saw during the pandemic. Companies facing uncertain market access will likely pause in the near term, reduce investment and cut spending. Likewise, financial institutions will reassess borrowers’ exposure. The increased uncertainty and tightening of financial conditions could well dominate the short term, weighing on economic activity, as reflected in the sharp decline in oil prices.

The effect of tariffs on exchange rates is complex. The United States, as the tariffing country, may see its currency appreciate as in previous episodes. However, greater policy uncertainty, dimmer US growth prospects, and an adjustment in the global demand for dollar assets—that has so far been orderly—can weigh down on the dollar, as we saw since the tariff announcements. In the medium term, the dollar may depreciate in real terms if the tariffs translate into lower productivity in the US tradable goods sector, relative to its trading partners.

Risks to the global economy have increased, and worsening trade tensions could further depress growth. Financial conditions could tighten further as markets react negatively to the diminished growth prospects and increased uncertainty. While banks remain well capitalised overall, financial markets may face more severe tests.

Growth prospects could, however, immediately improve if countries ease their current trade policy stance and forge new trade agreements. Addressing domestic imbalances can, over a period of years, offset economic risks and raise global output while contributing significantly to closing external imbalances.  For Europe, this means spending more on infrastructure to accelerate productivity growth. It also means boosting support for domestic demand in China, and stepping up fiscal consolidation in the United States.

Our policy recommendations call for prudence and improved collaboration. The first priority should be to restore trade policy stability and forge mutually beneficial arrangements. The global economy needs a clear and predictable trading system addressing longstanding gaps in international trading rules, including the pervasive use of non-tariff barriers or other trade-distorting measures. This will require improved cooperation.

Monetary policy will also need to remain agile. Some countries may confront steeper trade-offs between inflation and output. In others, inflation expectations may become less-well anchored, with a new inflation shock following closely after the prior one. Countries that encounter resurgent price pressures will require forceful monetary tightening. For others, the negative demand shock will warrant lower policy rates. Monetary policy credibility will be important in all cases, and central bank independence remains a cornerstone.

The increased external volatility from tariff adjustments and a possibly prolonged risk-off environment, may be difficult to navigate for emerging markets. Our Integrated Policy Framework emphasises that it is important to let currencies adjust when driven by fundamental forces, as is the case now, and spells out the specific conditions where it is advisable for countries to intervene.

Fiscal authorities face starker trade-offs with high debt, low growth and rising financial costs. Most countries still have too little fiscal space and need to implement gradual and credible consolidation plans, while some of the poorest countries, also hit with reduced official aid, could experience debt distress.

New spending needs are further weighing on fiscal fragilities. Calls for support will increase for those at risk of severe dislocation from the shocks. Such support should remain narrowly targeted and incorporate automatic sunset clauses. The experience of the last four years suggests that it is easier to open the tap of fiscal support than to close it.

Some countries, especially in Europe, face new and permanent increases in
defense-related spending. How should these be financed? For countries with sufficient fiscal space, only the temporary part of the additional spending—that is, temporary support to help adapt to the new environment or the initial bulge in spending to rebuild defense capabilities—should be financed by debt. For all other countries, new spending needs should be offset by spending cuts elsewhere or new revenues.

We should not lose sight of the need for stronger growth. Governments should continue to engage in fiscal and structural reforms that help mobilise private resources and reduce resource misallocation. They should also invest in the digital infrastructure and training necessary to benefit from new technologies such as artificial intelligence.

Finally, we should ask ourselves why our global system warrants remapping—and recognise that decades of deepening trade ties fostered rapid but uneven economic growth. In many advanced economies, there is an acute perception that globalisation unfairly displaced many domestic manufacturing jobs. There is some merit to these grievances, even if the share of manufacturing employment in advanced economies has been in a secular decline in countries running trade surpluses, like Germany, or deficits, like the United States.

The deeper force behind this decline is technological progress and automation, not globalisation: in both countries the output share of manufacturing has remained stable. Both forces are ultimately beneficial but can be very disruptive to individuals and communities. It is a collective responsibility to ensure the right balance between the pace of progress or globalisation and addressing the associated dislocations.

This requires that policymakers think well beyond the reductive lens of compensating transfers between ”winners” and ”losers,” be it of technological revolutions or globalisation. In this, unfortunately not enough has been done, pushing many to embrace a zero-sum worldview whereby the gains of some only come at the expense of others. Instead, it is important to better understand these root causes so that we can build an improved trading system that delivers more opportunities. This objective is enshrined in our Articles of Agreement, which ask us “to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income.”

Global integration is not an objective in and of itself. It is a means to an end, important insofar as it supports improved living standards for all.

—This blog is based on Chapter 1 of the April 2025 World Economic Outlook, “Policy Uncertainty Tests Global Resilience.”

All authors are economists economists at the IMF. This article was originally posted here.