Policy shocks and rising uncertainty are weakening the global outlook

The global economy remains on track to grow this year, but the outlook has deteriorated significantly in recent months. Major policy shifts in the United States—particularly the introduction of new tariffs—are weighing on activity and fueling a high level of uncertainty across economies.

Real global GDP is now projected to increase by just 2.7 percent in 2025 and 2.8 percent in 2026, down from a 3.2 percent gain last year, according to an analysis presented at the Peterson Institute for International Economics event, Global Economic Prospects: Spring 2025. US tariffs are raising prices, disrupting supply chains, and eroding real incomes. These direct effects are being compounded by a volatile and unpredictable policy environment, as frequent changes to announced tariffs have made it harder for businesses to plan and invest.

Other recent policy actions are adding to the drag in the United States. Federal layoffs and operational disruptions tied to the new Department of Government Efficiency are reinforcing uncertainty without meaningfully improving the fiscal position. A large fiscal legislative package expected later this year also is likely to do little to reduce the federal budget deficit relative to current policies. On balance, the fiscal package will likely be a modest negative for demand relative to current policies: The extension of the 2017 tax cuts will have a roughly neutral effect, and any additional tax relief appears set to be slightly outweighed by spending reductions.

Altogether, US economic growth is expected to stall this year, with average annualized growth projected to step down from 2.5 percent in 2024 to just 0.1 percent in 2025 (see figure below). Inflation is projected to peak at around 4.5 percent later this year and unemployment to rise to a bit above 5 percent before improving in 2026. Financial markets have reacted negatively to recent policy changes, though hard data on spending and employment remain relatively firm. That resilience may reflect, in part, a shift in timing as households and businesses pull forward purchases in anticipation of higher prices.

Monetary policymakers face a difficult balancing act. The Federal Reserve is expected to hold interest rates steady through year-end, waiting for clearer signs that inflation is easing before making cuts. In the meantime, policy decisions will be complicated by uncertainty around both inflation expectations and the neutral rate of interest.

Outside the United States, the picture is mixed

Canada and Mexico are being hit hard by new US trade actions. Mexico faces added challenges from weaker economic fundamentals and anticipated revisions to the terms of the US-Mexico-Canada agreement (USMCA)—though movement of some production to Mexico from other countries may offer some offsetting benefits. In Europe and the United Kingdom, moderate growth is expected, with the euro area in particular supported by coordinated debt issuance and increased defense spending.

In China, growth is expected to fall well short of the government’s 5 percent target. Structural challenges, fragile consumer sentiment, and heightened tensions with the United States are all weighing on the outlook, while fiscal and monetary stimulus have so far had only limited effect.

Elsewhere in Asia, prospects vary widely and remain highly sensitive to further developments in trade policy. Many economies are exposed to the risk of additional US tariffs. India, however, continues to attract foreign investment and remains a regional bright spot.

Risks to the outlook

Significant risks to the outlook remain. The probability of a US recession over the next 12 months is now estimated at 40 percent. Several factors could amplify the current drag, including a deeper equity market correction, rising interest rates driven by fiscal concerns, or renewed monetary tightening if inflation expectations become unanchored. Any additional weakness in the US economy would weigh heavily on global growth, particularly for US trading partners.

The outlook could also turn out better than currently projected if policy shifts. A meaningful reversal of recent tariff hikes would relieve some of the inflationary pressure and help restore business confidence. Coupled with continued advances in artificial intelligence, deregulation, and investment incentives, such a change could support stronger productivity growth.

In short, while the foundation for global economic expansion remains in place, the outlook for the next two years is unusually dependent on US policy—and whether recent negative developments prove temporary or become more entrenched.