Global economy at a crossroads

The global economic landscape is undergoing a profound transformation, according to a newly released report from the International Monetary Fund (IMF). The analysis, authored by IMF chief economist Pierre-Olivier Gourinchas, paints a sobering picture of a world economy navigating through rising trade tensions and policy uncertainty.

Resetting economic systems

Since late January 2025, a spate of tariff announcements from the U.S. has dramatically altered the global trade environment. What began with targeted tariffs against certain countries (such as Canada, China and Mexico) and in critical sectors culminated in near-universal levies. The impact has been immediate and severe – U.S. effective tariff rates have surged past levels not seen since the Great Depression, while retaliatory measures from major trading partners have significantly pushed up global tariff rates.

“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,” said Gourinchas. “Existing rules are challenged while new ones are yet to emerge.”

This abrupt shift has created what the IMF terms “epistemic uncertainty” – a fundamental unpredictability about the rules governing global trade – which has become a major driver of the economic outlook. The resulting forecasts reflect this complexity, with the IMF presenting multiple scenarios based on different potential developments in trade policy.

Read: IMF cuts MENA 2025 growth forecast to 2.6 percent as global policy uncertainty looms

Growth projections downgraded

The IMF’s reference forecast, which includes tariff announcements between February 1 and April 4 by the U.S. and countermeasures by other countries, shows global growth declining to 2.8 percent in 2025 and 3 percent in 2026. This represents a cumulative downgrade of approximately 0.8 percentage points compared to the January 2025 World Economic Outlook update.

Had the April tariffs not been implemented, the IMF estimates that global growth would have experienced only a modest cumulative downgrade of 0.2 percentage points, reaching 3.2 percent for both 2025 and 2026. This stark difference underscores the significant economic cost of escalating  trade tensions. Despite the slowdown, global growth remains above recession levels.

However, global trade growth is projected to dip more than output, falling to just 1.7 percent in 2025 – a significant downward revision from previous forecasts.

Uneven impact across markets

The impact of tariffs varies substantially across countries. For the U.S., which has implemented the tariffs, the result is a negative supply shock. The IMF has lowered its US growth estimate for 2025

to 1.8 percent – 0.9 percentage points lower than January projections, with tariffs accounting for 0.4 percentage points of that reduction. US inflation forecasts have also been raised by about 1 percentage point, up from 2 percent. For trading partners, tariffs primarily represent a negative demand shock.

China’s growth forecast for 2025 has been cut to 4 percent, a 0.6 percentage point reduction, while inflation estimates have been revised downward by about 0.8 percentage points. The euro area, facing relatively lower effective tariffs, has seen its growth forecast revised down by 0.2 percentage points to 0.8 percent.

The IMF notes that both China and the euro area will benefit from stronger fiscal stimulus this year and next, providing some economic support. Emerging market economies face varying prospects depending on where tariffs ultimately settle, with the IMF lowering its overall growth forecast for this group by 0.5 percentage points to 3.7 percent for 2025.

Complex economic mechanisms at work

The latest IMF report highlights several key mechanisms through which tariffs and trade tensions affect the global economy:

1. Global supply chain magnification: Most traded goods are intermediate inputs that cross borders multiple times before becoming final products. Disruptions can propagate throughout global input-output networks with potentially large multiplier effects.
2. Investment hesitation: Companies facing uncertain market access are likely to pause investments and reduce spending, while financial institutions reassess borrowers’ exposure to trade disruption.
3. Exchange rate complexity: The effect on exchange rates is multifaceted. While the US, as the tariffing country, might see currency appreciation as in previous episodes, factors such as policy uncertainty and dimmer growth prospects could weigh on the dollar.
4. Financial market reactions: Increased uncertainty and tightening financial conditions could dominate in the short term, as reflected in the sharp decline in oil prices following tariff announcements.

Policy recommendations for a fragile economy

The IMF offers several recommendations for navigating this uncertain environment:

1. Restore trade policy stability: The first priority should be to forge mutually beneficial trade arrangements and create a clear, predictable trading system that addresses longstanding gaps in international rules.
2. Adaptive monetary policy: Central banks must remain agile, with some countries potentially facing steeper trade-offs between inflation and output. Those encountering resurgent price pressures will require forceful monetary tightening, while others experiencing negative demand shocks may need to lower policy rates.
3. Fiscal prudence: With high debt, low growth, and rising financial costs, most countries need to implement gradual and credible fiscal consolidation plans. Support for those affected by economic dislocation should remain narrowly targeted with automatic sunset clauses.
4. Growth-oriented reforms:

Governments should continue fiscal and structural reforms that mobilize private resources and reduce resource misallocation, while investing in digital infrastructure and training necessary to benefit from technologies like artificial intelligence.

Tough choices to be made

The report concludes with a call for policymakers to think beyond “winners” and “losers” in globalization. Gourinchas noted that while there is merit to grievances about job displacement in advanced economies, the deeper force behind manufacturing employment decline is technological progress and automation, not globalization. In both trade surplus countries like Germany and deficit countries like the U.S., manufacturing output share has remained stable even as employment has declined.

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

The IMF’s analysis makes clear that how nations respond to this pivotal moment will determine whether the global economy can navigate through current tensions toward renewed cooperation, or whether it faces a more fragmented and less prosperous future.

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