ANALYSIS

OCTOBER /two.case/zero.case/two.case/four.case

AUTHORS

Mark Zandi

Mark.Zandi@moodys.com Chief Economist

Brendan LaCerda

Brendan.LaCerda@moodys.com

Director/Senior Economist

Justin Begley

Justin.Begley@moodys.com

Economist

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The Macroeconomic Fallout of Trump's Tariff Proposals

The/uni00A0U.S./uni00A0presidential election is just a few weeks away, and former President Donald Trump and Vice President Kamala Harris are relentlessly campaigning to draw in the few remaining undecided voters. Both are focusing their messaging on the economy with Trump vowing to bring down prices, cut taxes, and protect domestic manufacturing, while Harris is making appeals to the lower and middle class and small businesses, and promising to address the housing shortage and support the nation's manufacturing base.

The Macroeconomic Fallout of Trump's Tariff

Proposals

BY MARK ZANDI, BRENDAN LACERDA AND JUSTIN BEGLEY

The/uni00A0U.S./uni00A0presidential election is just a few weeks away, and former President Donald Trump and Vice President Kamala Harris are relentlessly campaigning to draw in the few remaining undecided voters. Both are focusing their messaging on the economy with Trump vowing to bring down prices, cut taxes, and protect domestic manufacturing, while Harris is making appeals to the lower and middle class and small businesses, and promising to address the housing shortage and support the nation's manufacturing base.

Trade policy is key to Trump's policy agenda. He has proposed a 10% universal tariff on U.S. imports, an effort to protect goods-producing industries domestically and raise revenues for the federal government. He has also floated a higher 60% tariff on goods originating in/uni00A0China/uni00A0and a full decoupling from that nation for national security purposes. Together, these would raise the effective tariff rate from its current 3% to a historically high 19% (see Chart 1).

Chart 1: Trump Tariffs Would Significantly Raise the Effective Tariff Rate

Effective tariff rate*, %



*Import duty revenues as share of total goods imports

Sources: Department of Commerce, World Bank, Goldman Sachs Global Investment Research, Moody's Analytics

ASSUMPTIONS

We use the Moody's Analytics U.S. macro model to assess the economic consequences of Trump's tariff proposal. Our baseline (most likely) forecast assumes that Harris wins the election, Republicans win a majority in the Senate, and Democrats secure a majority in the House, resulting mostly in legislative gridlock.

In contrast to our previous election scenarios, where we incorporate the candidates' entire platforms, here we isolate the effects of Trump's proposed tariff policies. Of Trump's various campaign promises, his trade policy is the most likely to be implemented, since the president has near-complete authority to unilaterally make foreign policy decisions.

We assume Trump does not follow through on his 60% tariff promise on Chinese imports. Instead, we assume a uniform import levy of 10% on all countries. As in the trade wars during Trump's first term, we anticipate many U.S. trading partners will respond with higher tariffs of their own on U.S. goods they are importing. To determine the magnitude of the retaliatory tariffs, we rely on the expert judgment of our country economists, who weigh a wide range of economic, political and geopolitical factors (see Table 1).

SCOPE AND SCALE

The tariff increases Trump imposed in his first/uni00A0term were limited. At their peak in 2019, they impacted about $300 billion in goods, equal to 10% of U.S. imports, and were limited to specific products, mostly coming from China. They nonetheless did measurable economic damage, particularly to the agriculture, manufacturing and transportation industries. A tariff increase covering nearly all goods imports, as Trump has proposed, goes far beyond any previous action./uni00A0Goods imports/uni00A0account for more than $3 trillion, or more than 10% of U.S. domestic demand, su/g_g.ligaesting that more than a tenth of consumer goods will face price hikes, since higher import prices give domestic producers greater power to raise their own prices (see Chart 2).

Chart 2: Scope and Scale of Tariff Impact

Trade volume measures, %, share of domestic demand



Sources: BEA, Moody's Analytics

Moreover, the magnitude of the economic effects of Trump's tariff proposal intensify as trade partners' retaliation escalates. Country economists at Moody's Analytics assess that most nations will respond to the 10% tariff by placing tariffs on U.S. exports, which account for

Share of U.S. imports by goods, 2023

more than 7% of domestic demand. Of the countries that retaliate, China and/uni00A0Mexico/uni00A0are assumed to respond in kind with a similar tariff rate, while the European Union places a 7% tariff on imports from the U.S. Several other countries-such as/uni00A0Canada/uni00A0and/uni00A0Brazil-will retaliate but to a smaller degree. Economies with little to no trade relationship with the U.S. and those more vulnerable to trade disruptions will not retaliate (see Chart 3).

Chart 3: Global Retaliation to Higher U.S. Tariffs

Change in tariff rate on goods imported from the U.S.



Source: Moody's Analytics

MACROECONOMIC CONSEQUENCES

Trump's proposed tariff policy raises costs for businesses and in turn/uni00A0weighs on growth and productivity. The tariffs accelerate inflation as businesses pass much of their higher costs to consumers.

Growth in core producer prices, which excludes food and energy, quickly accelerates with the year-over-year rate rising to its highest since the third quarter of 2022, when inflation was near its cycle peak. At its peak impact, the 10% universal tariff is projected to raise the year-ago rate of growth in core producer prices by 6.1 percentage points above our baseline forecast. Firms do not bear the full weight of the tariff, however, and are able to pass some of their increased cost of goods down to consumers. As a result, annual growth in core consumer price inflation is projected to rise 1.1 percentage point above the baseline forecast at its peak, reversing much of the recent progress made on quelling inflation (see Chart 4).

As inflation accelerates, consumers pull back on spending and businesses on investment. Exports also fall more than imports because of a combination of trade disruptions hurting supply chains, retaliation from major trade partners, and a stronger U.S. dollar. As a result, the trade deficit widens and weighs on real GDP. Together, these cause the U.S. economy to slip into a mild and brief technical recession by mid- to late 2025, and the economy ends up on a weaker path as a result (see Chart 5).

>7%

7%

>0 to <7

0%

Chart 4: Tariffs Will Push Up Inflation on Consumers and Producers…



Sources: BLS, Moody's Analytics

Chart 5: …As the Economy Enters a Short and Mild Recession

Real GDP, $ tril, SAAR



Sources: BEA, Moody's Analytics

The economic contraction leads employers to reduce hiring and lay off workers. The unemployment rate peaks at 5.3% in the third quarter of 2026, 1.3 percentage points above the baseline. Industries that disproportionately rely on imports for inputs, such as construction and manufacturing, will take the greatest hit, though all industries are worse off in terms of total employment due to broader weakness in the economy (see Charts 6 and 7).

Chart 6: New Unemployment Concerns

Unemployment rate, %

Chart 7: Import-Sensitive Industries Will Take the Biggest Hit

Nonfarm payrolls, total additions, 2025-2028, ths



Sources: BLS, Moody's Analytics

Higher inflation moves the Federal Reserve to slow the pace of its interest rate reductions. The Federal Open Market Committee began loosening monetary policy in September with a 50-basis point rate cut, citing progress on returning inflation back to target and a renewed focus on its dual mandate of stable prices and maximum employment. Higher tariffs, however, shift the balance of risks back toward inflation, so the Fed allows unemployment to rise by keeping the fed funds rate higher for longer to bring inflation back to 2% (see Chart 8).

Chart 8: Higher Interest Rates From Inflation Spike Drive Up Interest Costs...



Higher interest rates put additional pressure on the federal budget deficit, as interest outlays rise. The federal government's interest expense has risen nearly 40% over the past year as a result of higher coupon rates on U.S. Treasury securities, which were driven up by the Fed's monetary policy. Tighter Fed policy stemming from higher tariffs will result in more expensive borrowing by the federal government, pushing interest outlays well above defense spending by the end of Trump's second term and causing the federal interest expense-to-GDP ratio to rise to its highest since the late 1990s.

Additional spending on interest expenses increases the pressure on the federal budget deficit and debt. Automatic stabilizers from the federal government due to kick in as the economy enters a downturn will expand the budget deficit further. As a result, the increased revenue from tariffs-estimated to be around $319 billion over Trump's four-year term-will not be enough to offset the estimated $776 billion increase in federal government spending. Consequently, the federal budget deficit widens to about -6% of nominal GDP compared with about -5% in the baseline and the debt-to-GDP ratio surpasses 110% by the end of Trump's time in office compared with our baseline forecast of 105% (see Chart 9).

SHAKY MARKETS AND CONFIDENCE

Trump's tariff proposal will also inject additional uncertainty into the economy that will be seen both in financial markets and among consumers. Uncertainty regarding a global trade war emanating from the U.S., disruptions to trade flows and supply chains, higher inflation, higher interest rates, and an ensuing recession will shake investor confidence. As a result, stock market volatility will spike to roughly where it was when inflation peaked in mid-2022 and a selloff will commence, resulting in weaker stock prices than in the baseline. Larger budget deficits, a higher federal debt burden, and increased policy uncertainty will also push longer-dated Treasury yields higher (see Chart 10).

Chart 9: …Putting Further Stress on the U.S. Fiscal Situation

Federal budget deficit, % of nominal GDP



Sources: U.S. Treasury, BEA, Moody's Analytics

Chart 10: Expect Increased Market Volatility and Higher Long-Term Rates…

S&P 500

7,000

6,000

5,000

4,000

3,000

2,000



19

20

21

22

23

24

25

26

27

28

Index, Trump Tariff Scenario (L)

Index, May baseline (L)

Volatility index, May baseline (R)

Volatility index, Trump Tariff Scenario (R)

Sources: S&P, Federal Reserve, Moody's Analytics

Anxiety among consumers will also mount as prices rise and the economy dips into a recession. Consumer confidence dives as a result and remains below the long-run average through the remainder of Trump's term (see Chart 11).

Chart 11: …And Weaker Consumer Sentiment

Consumer confidence, 1985=100



Sources: The Conference Board, Moody's Analytics

GLOBAL IMPACT

The global economy will not be spared from the higher tariffs levied by Trump. The ensuing trade war will result in a weaker global economy as major U.S. trading partners' economies shrink. However, the magnitude of the economic shock from Trump's tariffs for each country depends on how linked it is with the U.S. in terms of trade and the degree of retaliation. Even so, the U.S. will face the largest adverse impact because of its central role in sparking the ensuing trade war (see Chart 12).

Chart 12: Global Impact of Trump Tariffs

Real GDP by country, Republican Sweep scenario, devation from baseline forecast, ppts

0




• Sources: BEA, BLS, Census Bureau, Treasury, Federal Reserve, S&P, FHFA, Moody's Analytics
• *Differences from baseline may appear inexact due to rounding.

ABOUT THE AUTHORS

Mark Zandi is chief economist of Moody's Analytics, where he directs economic research. Moody's Analytics, a subsidiary of Moody's Corp., is a leading provider of economic research, data and analytical tools. Dr. Zandi is a cofounder of Economy.com, which Moody's purchased in 2005. Dr. Zandi is on the board of directors of MGIC, the largest private mortgage insurance company in the U.S., and is the lead director of PolicyMap, a data visualisation and analytics company, which is used by policymakers and commercial businesses.

He is a trusted adviser to policymakers and an influential source of economic analysis for businesses, journalists and the public. Dr. Zandi frequently testifies before Congress and conducts regular briefings on the economy for corporate boards, trade associations, and policymakers at all levels.

Dr. Zandi is the author of Paying the Price: Ending the Great Recession and Beginning a New American Century, which provides an assessment of the monetary and fiscal policy response to the Great Recession. His other book, Financial Shock: A 360° Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis, is described by The New York Times as the 'clearest guide' to the financial crisis.

Dr. Zandi is host of the Inside Economics podcast. Dr. Zandi earned his BS from the Wharton School at the University of Pennsylvania.

Brendan LaCerda is a director and senior economist with Moody's Analytics. Brendan serves as the lead analyst for the Canadian economic forecast. His primary responsibilities also include the development and improvement of country forecast models. His research is primarily focused on international macroeconomics, healthcare and fiscal policy. Before joining Moody's Analytics, Brendan worked as a senior economist with IHS Global Insight's U.S. Macroeconomic Service. Brendan received his PhD in economics from the University of Virginia. He pursued his undergraduate education at the London School of Economics and the University of Notre Dame, where he graduated with a BA in economics and mathematics.

Justin Begley is a U.S.-based economist at Moody's Analytics. He covers the economies of Minnesota, Alabama, Wyoming, and several U.S. metro areas. His research focuses on U.S. fiscal policy, geopolitical risk, and the U.S. labor market. He also works on developing models to forecast high-frequency data of the U.S. economy and is a regular contributor to Economic View. Prior to joining Moody's Analytics, Justin held fellowships at Florida State University and in political economy at the Mercatus Center at George Mason University. Justin holds a master's of science in economics from Florida State University and a bachelor's degree in finance and economics from Canisius College.

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