The US economy has had the strongest recovery from the COVID-19 pandemic of any major developed economy. Annual inflation is approaching the Federal Reserve’s target without a recession, non-managerial real wages have exceeded pre-pandemic trends, consumer spending is continuing to exceed expectations, investment in factories is at record levels, and the United States is a net exporter of petroleum products.1
Against this backdrop, in January a new administration will take charge of government. Initial market response to the news was favorable,2 with the expectation that the new administration will be able to build on the economy’s strong foundations and unlock further growth. At the same time, there remains uncertainty around the potential implications of economic policies of the incoming administration.
During the campaign, the president-elect proposed a range of economic policy changes.3 Our baseline scenario anticipates that many of these policies will not be implemented in their most maximalist forms. For instance, while we expect the introduction of some new tariffs, we do not foresee the implementation of the across-the-board tariffs that were occasionally floated during the campaign. Similarly, while we expect there may be an increase in deportations of undocumented immigrants, legal immigration levels could remain relatively unaffected.
However, this forecast is among the most uncertain in recent times, so we include two alternate scenarios to capture a full range of possible outcomes for the coming years. Our upside scenario reflects markets’ positive reactions to the election, and includes tax cuts, increased investment and productivity, and a minimum of harmful tariffs. Our downside scenario, on the other hand, includes a wide range of tariffs, significant deportations, and sweeping cuts to government spending.
Scenarios
Baseline (50%): In our baseline scenario, we expect the new administration to be judicious in how they implement their campaign promises. We foresee new tariffs on China and some targeted tariffs on other trading partners, but none on Canada or Mexico, and many categories of goods—such as food and energy products—will be spared. Similarly, while we expect deportations to run above their current levels, this scenario does not foresee millions of deportations as this would cause food prices to rise given that nearly half of the agricultural workforce is made up of undocumented immigrants;4 voter anger with high food prices was a significant factor in the election outcome, and the new administration is expected to be sensitive to that. Significant government spending cuts are enacted, but these are not enough to change the overall economic picture. There are also some easy wins: Tax cuts under the Tax Cuts and Jobs Act (TCJA) are extended, and the Fed remains independent.
In this scenario, individuals and businesses front-load some trade activity in 2025 to avoid tariffs, with exports growing by 3.2% and imports growing by 4.4%. Once tariffs take full effect in 2026, both exports and imports grow by just 0.7%. The inflationary effects of tariffs mean inflation rises again, and the Fed is forced to pause rate cuts until mid-2027. Consumer spending grows by 3.1% in 2025 and 2.3% in 2026; overall consumer spending growth remains low throughout the remainder of the forecast horizon, averaging 1.8% per year as deportations hold back population growth. Government spending cuts are fully implemented in the 2026 fiscal year and further subtract from growth. Overall, our modeling shows real GDP growth of 2.4% in 2025 before slowing to 1.7% in 2026. GDP growth then ranges from 1.9% to 2.1% between 2027 and 2029.
Tax cuts, trade deals and deregulation (30%): Markets reacted positively to the election results. Investors clearly believe the new administration can unlock a new level of growth through tax cuts and deregulation. In this scenario, we examine what might happen if these hopes come true. The TCJA tax cuts are extended, and the corporate tax rate is lowered to 15% for domestic producers as per a campaign promise,5 prompting a boost in investment. That additional investment, as well as the successful introduction of novel technologies like AI to workplaces, results in a productivity boom. We see this scenario as about equally as likely as the baseline.
We include minimal new tariffs in this scenario, working on the theory that the president-elect will use the threat of tariffs to successfully strike new trade deals on favorable terms. In addition, businesses convince the administration to limit deportations in the name of keeping prices low.
In this scenario, GDP will rise more rapidly than the baseline forecast through to 2029. Between 2025 and 2029, this scenario expects GDP to rise at an average annual rate of 2.7%, which is 0.7 percentage points above the average in the baseline forecast. With fewer tariffs in place, this scenario also predicts lower inflation compared to the baseline, stronger consumer spending starting in 2026, and a lower merchandise trade deficit. However, due to the inflationary impact of the tax cuts, inflation does settle around 2.3% per year by the outer years of the forecast, higher than in the status quo ante. Finally, with fewer deportations, labor markets will not be as greatly impacted as in the baseline. The labor supply will rise above the levels in the baseline scenario, and consequently, so will employment, limiting the gains in the unemployment rate.
Accelerating inflation and shrinking population (20%): While our baseline expects some policy changes from the incoming administration, it reflects a relatively minimalist version of what was promised on the campaign trail. There is a possibility that some of the more impactful policy proposals could be implemented in full, and we therefore model an alternate scenario where many promises are implemented more fully.
The full range of promised tariffs (60% on all goods from China, 20% on goods from all other trading partners6) are introduced, resulting in a major reduction in both exports and imports and a broader economic slowdown. Deportations reach 1 million people per year and legal immigration levels are cut in half, with the result that the US population is lower in 2029 than it is today. A total of US$1.35 trillion is cut from federal government spending, achieved through deep cuts to Medicaid transfers, social security payments, and income security programs, representing a big decrease in the living standards of millions of Americans.
Overall, economic growth slows considerably to 1.6% in 2025 before the economy suffers an outright contraction of 2.1% in 2026, a recession of similar magnitude to those we experienced in 2020 and 2009. The economy is expected to run weaker for longer as rising trade tensions and the sustained enforcement of the new immigration policy keep consumption growth in the red for most of the forecast. Inflation also trends higher for longer, peaking at 3.7% in 2026 before easing gradually to 3% by the end of the forecast. With these inflationary pressures, we expect the Fed to enter a new rate hiking cycle in 2026 before again beginning to ease monetary policy in 2027.
To some extent, the weaker economy in this scenario is not surprising: The stated purpose of tariffs is to re-shore manufacturing to the United States, but that process will take time, so any benefits of such a policy will not be felt during the next four years. The policy of mass deportations would likely have a profound effect on industries like agriculture and hospitality, where undocumented workers make up a significant share of the total workforce. Likewise, making deep cuts to government spending and transfers will always be a net negative to the macroeconomy in the short term.
Consumer spending
Real consumer spending remains strong. In September, real personal consumption expenditures (PCE) increased 0.4% after a 0.2% rise in August. For the third quarter of 2024, overall real PCE rose 3.7% (at annual rates), stronger than the 2.8% growth recorded in the second quarter, with spending on goods, specifically durable goods, remaining elevated. Real consumer spending on durable goods grew 8.1% in the third quarter after rising more than 5% in the second quarter of this year. Generally, increased spending on durables is seen as a signal of rising consumer confidence.
Households depleted their pandemic-era excess savings in March of this year,7 and thus gains in consumer spending in the short term are expected to be driven by growing income and the ability of households to add new debt. Household debt continued to rise, increasing by US$147 billion in the third quarter of 2024, which increased consumer’s spending capacity.8
In the coming quarters, the Fed’s expected rate cuts will make borrowing cheaper, enabling households to take on more debt, and therefore providing breathing room for households to continue spending until 2025. We also expect consumers will be doing some front-loading in late 2024 and 2025 to try to get ahead of tariffs, which we see coming into full force in 2026. Starting that year, the tariffs will impact households’ real purchasing power. Consumer spending will also be negatively affected by the broader economic slowdown caused by the tariffs and government spending cuts. Additionally, our forecasts are for aggregate consumer spending, and as deportations continue, the number of people spending money in the economy will be lower than in the status quo. Nonetheless, the underlying strength of the consumer means we do not see any outright declines in spending.
Overall, we forecast consumer spending will rise 2.8% this year and another 2.4% in 2025 before growing at a slower 1.7% pace in 2026. Lower interest rates should help boost demand for durable goods, boosting spending on that category by 4.7% in 2025 before tariffs bring growth to just 1.9% in 2026. Spending on non-durables is expected to rise by 2.5% in 2025 and 0.8% in 2026. Finally, spending on services is expected to increase by 2.9% in 2025 and by a similar amount in 2026, given that services will not be impacted by tariffs.Home building has been more heavily impacted by high interest rates than other categories of investment. In October, both housing starts and building permits fell for the second month in a row, as elevated rates continue to weigh on affordability for buyers and on the ability of builders to borrow. During the 2010s, housing starts did not return to their peak levels from before the global financial crisis of 2008–2009. The long-term failure to build enough homes has contributed to the housing crisis we see today in some parts of the country, and we may have to wait for rates to drop to see a significant uptick in housing construction. One opportunity for the new administration could be to pursue something like the Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act, but for building housing.
We expect housing starts to continue falling in the last quarter of this year before rising again in 2025 to 1.4 million as interest rates fall, encouraging more construction. We also anticipate housing starts to increase above 1.5 million in 2026 and remain around 1.5 million for the rest of the forecast. In 2025 and 2026, the housing stock is expected to rise more rapidly than total population, helped in part by the slower population growth.
Despite a strong level of construction in the medium term, for there to be a real impact on affordability, more of this new construction will need to be “starter homes” and will need to be built in parts of the country experiencing the largest increases in population. We expect this to continue to be a challenge. Consequently, the house price index is forecasted to rise by 4.8% in 2024, with growth expected to slow to 2.9% in 2025. In the outer year of the forecast, the house price index is expected to rise more rapidly once again.
Business investment
Investment is spending that helps grow the long-term productive capacity of the economy, and as such, is the most important sector for understanding an economy’s potential. Investment in structures, which includes both buildings and engineering structures such as power plants and oil platforms, has typically followed a cyclical pattern, and is often driven by commodity price booms and economic cycles. However, the main factor driving growth in this investment class since the pandemic, especially in manufacturing construction investment, has been the passage of the Inflation Reduction Act and the CHIPS and Science Act. These pieces of legislation aimed to increase US production of strategic technologies like electric vehicles, batteries, renewable energy, and semiconductors.9 Since the passage of these pieces of legislation in August of 2022, spending on manufacturing construction has risen to historic highs, with investment in structures increasing 10.8% in 2023. Although House Speaker Mike Johnson has floated the possibility of repealing these pieces of legislation,10 we do not expect that to happen. Both pieces of legislation are popular, and their benefits are skewed toward Republican districts, making it unlikely they will be able to get enough votes for a repeal with their slim majority in the House.
As factory construction increases, so do machinery and equipment (M&E) investment and intellectual property (IP) investment, which capture everything from plant machinery and computers to software. M&E and IP investments increased significantly since the start of 2024. We predict the rise in manufacturing construction activity to continue to increase investments in M&E and IP. Overall, our forecast shows M&E investments rising 5.1% in 2025 and 5.4% in 2026. This type of spending has seen a strong upward trend over time, and we expect that strong trend growth to remain throughout the rest of the forecast period. Business investments in IP, which include not only software purchases but also research and development spending, increased significantly during the pandemic as firms adapted to new work-from-home realities. Growth in IP investment is expected to slow compared to the gains observed in 2021 and 2022 but will remain high over the course of the forecast period as many sectors incorporate artificial intelligence and other technologies.
While higher interest rates are used to combat inflation by reducing demand, they can paradoxically cause inflationary pressures to persist for longer by making it more expensive for firms to invest in the capacity to produce more and relieve supply pressures. The average corporate borrowing rate increased to nearly 7% by the end of 2023 and remained elevated through the first three quarters of 2024, presenting a barrier to firms who need to borrow to invest. However, many firms still have more cash on hand than they did before the pandemic11 and can consequently avoid borrowing at these rates. As a result, business investment has been coming in relatively strong since the start of the year. Further rate cuts from the Fed should help contribute to a positive environment for business investment. This should be felt in particularly rate-sensitive categories of investment like housing and commercial real estate, both of which have been weak during the current high-interest rate environment.
Looking ahead, markets seem to expect the incoming administration will further boost the attractiveness of business investment. All our scenarios foresee the extension of the tax cuts put in place through the TCJA, which were set to expire in 2025, as well as the lowering of the corporate tax rate and cuts to some regulations. As a result of all these factors, non-residential business investment is projected to increase 3.9% this year, 3.7% in 2025, and another 4.7% in 2026. Growth in business investment is expected to rise even further in 2027 and remain elevated in the outer years of the forecast.
Foreign trade
Foreign trade is the sector with the biggest question mark surrounding it. The president-elect has promised to introduce 60% tariffs on goods imported from China and a 10% to 20% tariff on goods imported from all other trading partners. At present, 14% of goods imports come from China and a total of 38% of all goods imports come from countries without a trade agreement. If the proposed tariffs are only imposed on this group of trading partners, the average tariff rate on imported goods would reach 11.8%. There is some debate about whether the White House can impose these tariffs unilaterally, but at the very least they will not immediately be able to do so on goods imported from countries with which the Unites States has a free trade agreement. We expect this will provide an opportunity for countries to negotiate deals to avoid tariffs.
Additionally, there are good political reasons to expect broad categories of critical goods, such as food or energy, to be exempted from tariffs altogether. With this in mind, our baseline scenario models the impact of an average tariff of 30% on Chinese goods and an average tariff of 5% on goods imported from countries that are not part of the United States-Mexico-Canada Agreement.
Although the tariffs in our baseline scenario are less ambitious than the numbers floated on the campaign trail, their total effect is expected to be much greater than what we saw during the president-elect’s first term. The imposition of these tariffs is likely to turn into a complicated process involving individuals and businesses trying to make substitution decisions based on new relative prices. Until the tariffs take effect, we should continue to see growth in both imports and exports. We expect this will translate in a 3.1% increase in exports and a 4.4% increase in imports in 2025. Once the tariffs are officially put in place, we forecast both exports and imports to grow much more slowly: 0.7% each in 2026.
It may be a bit surprising to see that exports suffer as much as imports by the imposition of tariffs. There are a few reasons why this is the case in the short term, and why these tariffs may not have their desired impact in the long run. First, about half of imports are currently used as intermediate inputs by US businesses. It is likely to take some time for US producers to find local alternatives to the goods they are currently importing, and in the meantime, their cost of doing business will rise. This dynamic will reduce the money available to firms to invest and may drive some US producers out of business; it will also make their exports costlier and less competitive. Second, when the United States imposes tariffs on other countries’ goods, it has the side effect of causing the US dollar to appreciate, leading exports from the United States to become relatively more expensive in other markets. Tariffs will shield US producers from the import competition required to make globally competitive products. So, while they may dominate the US economy, they are likely to lose export sales, leading to limited net gain for American manufacturing.
Many of the theoretical benefits of tariffs would take much longer than four years to be realized, and so do not occur within our forecast horizon. There is not a large pool of American manufacturing production currently staffed up but sitting idle. Factories will need to be built and workers hired, both of which will take years to achieve. During this transition period when there are no US alternative goods, the cost of tariffs is likely to be borne by American households and businesses. In many cases, the reason for offshoring has as much to do with the availability of certain skills as it does cost, and reshoring all this production will require a major skills training program to ensure an adequate supply of workers.