Scenarios
Baseline (50%)2: Our baseline scenario aims to represent a “middle of the road” outcome. It is our assessment of the likely trajectory of the economy in the absence of major upside or downside risks. On the positive side, it includes an expansion of the Tax Cuts and Jobs Act (TCJA) and a modest boost from deregulation. However, we also assume a relatively modest increase in tariff rates, modest federal spending cuts, and a more stringent immigration policy that largely balance out the aforementioned expansionary policies.
We expect the TCJA will be extended, avoiding a sudden increase in income taxes, and we expect that the corporate tax rate will be lowered for American producers in line with campaign promises.3 Deregulation will continue throughout the next few years. The productivity boost from this is expected to remain relatively modest in the near term as policy uncertainty delays and limits the benefits of cutting red tape.
While it is not yet clear which tariffs will be introduced or which will “stick,” we do expect that there will be some level of new and lasting tariffs. We model this by adding five percentage points to the average tariff rate on all imported goods, which stood at 3.3% in 2024. We also expect that some spending cuts will prove lasting. Over the course of a few years, total net savings of US$200 billion are found in federal outlays compared with a scenario where there were no cuts (the actual dollar reduction in federal spending is much less than this number, because we bake in underlying spending growth due to population growth and inflation). Finally, we expect that deportations of undocumented immigrants will be lower than they were in 2024.
However, we expect the number of deportations to be about 15% higher than the average seen over the last five years.
In this scenario, individuals and businesses front-load some trade activity early in 2025 to avoid tariffs; as tariffs take effect, trade slows later this year and into next. We forecast real exports will grow by 0.7% in 2025 and 1% in 2026, while real imports will grow by 1.8% in 2025 and 0.9% in 2026. The inflationary effects of tariffs mean the Federal Reserve can only manage 75 basis points of cuts over the next 24 months. Real consumer spending grows by 2.9% in 2025 and 1.4% in 2026. Government spending cuts and layoffs continue over the next few years, which subtract value from overall growth. Overall, our modeling shows real GDP growth of 2.6% in 2025 and 2.1% in 2026. GDP growth then averages 1.9% per year over the remaining three years of the forecast.4
Trade deals and deregulation (25%): Our upside scenario explores the possibility that the economy could unlock a new level of growth thanks to productivity-enhancing technology, tax cuts, and deregulation. In this scenario, we examine what might happen if these hopes come true. As in the baseline, the TCJA tax cuts are extended, and the corporate tax rate is lowered to 15% for domestic producers. That, as well as breakthroughs in novel technologies like artificial intelligence, prompts a boost in investment, which results in a productivity boom.
We maintain tariffs at 2024 levels in this scenario, working on the theory that the new administration is primarily interested in using tariffs as a negotiating tactic to extract concessions from trading partners. Likewise, deportations under the current administration continue at a similar pace as the previous administration.
In this scenario, real GDP will rise by 2.9% in 2025 and 3.2% in 2026. Growth averages 2.9% over the remaining three years of the forecast—one percentage point above the average in the baseline scenario. 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. The booming economy results in a lower unemployment rate than in the baseline scenario.
Trade wars and persistent inflation (25%): While our baseline does incorporate some significant policy changes from the new administration, it does not reflect the full scope of potential changes to trade and immigration policy. We therefore modeled an alternate scenario where more impactful versions of these policies are implemented.
In this scenario, we raised the average tariff rate on goods imports by 10 percentage points. As a point of comparison, this magnitude of tariffs is approximately equivalent to a 25% tariff on Mexican and Canadian imports; the average import duty has not been this high since World War II. The tariffs raise the price of final goods for American consumers and raise the cost of intermediate imports for American producers. Exporters are also affected by the appreciation in the US dollar caused by the tariffs, making American products less affordable for foreign buyers.
As a result, exports are flat in 2025. While we do not model retaliation by trading partners in our scenarios, it is reasonable to assume that they would levy reciprocal tariffs or boycott American goods. The extent to which these dynamics further reduce American exports depend as much on psychology as on economics. While the tariffs could result in the reshoring of manufacturing to America, the macroeconomic benefits of this will take time to materialize.
We include larger government spending cuts in this scenario, with spending eventually falling US$1 trillion below its status quo trend. While a small portion of these cuts come from reductions in headcount and the consolidation of departments and agencies, other spending cuts will necessarily need to be enacted through the Congressional budget process. As in the baseline scenario, the TCJA tax cuts are extended, and the corporate tax rate is cut to 15% for American producers.
While the vice president has floated the possibility that 1 million undocumented immigrants could be deported each year under the new administration,5 we think it would be very difficult to deport such a large number of people. In this scenario, we allow deportations to rise by 250,000 per year, roughly doubling the rate of the previous administration. This reduces population growth and would have an impact on some industries, like agriculture and hospitality, where undocumented immigrants make up a significant share of the total workforce.
Overall, economic growth slows considerably to 2.2% in 2025 and 1.3% in 2026. The fight against inflation is slower than expected, and the Fed holds off on rate cuts in 2025 before beginning to cut again in 2026.
