How Tariffs Could Impact the Economy

The fundamentals of the US economy are showing cracks, as the unemployment rate is expected to rise and real income growth slowed sharply. Consumer and business confidence are also taking a hit.

In March, the Conference Board Consumer Confidence Index reached its lowest level since January 2021, while the University of Michigan Consumer Sentiment Index also noted decreases across all age cohorts.

How consumers and businesses feel about the economy can impact economic growth, as sentiments often influence consumer spending and business decisions. The worsening sentiment is largely driven by reinflation expectations considering the recent price hike in household staples like eggs and the anticipated impact of the Trump administration’s trade policies and continuing policy uncertainty.

The Trump administration has doubled down on larger wide-ranging tariffs, signaling greater willingness to tolerate near-term economic weakness in pursuit of its policies. Foreign consumer boycotts of American products and cancellations of their travel plans to the US are also taking a toll.

Goldman Sachs Research believes these factors may significantly slow economic growth, subsequently downgrading their 2025 US GDP growth forecast to 0.5% on a Q4/Q4 basis. Moreover, inflation, as measured by personal consumption expenditures (PCE), is expected to rise toward 3.5% by end of 2025. The forecast may change toward a potential recession outlook should the administration decide to press ahead with most or all of the announced reciprocal tariffs.

As the administration continues to seesaw through its economic policies, the uncertainty has produced potential headwinds for growth, but there are also tailwinds that could balance out the effects.

What are the economic headwinds?

Headwinds are factors that can slow down the economy. For example, they may include weakening consumer and business confidence, falling demand, rising costs, and increasing economic uncertainty.

Currently, one of the biggest concerns is how the administration’s fast-evolving trade policies, especially its use of tariffs, will play out. Recent statements from White House officials have indicated greater willingness to tolerate near-term economic weakness in pursuit of their policies.

Trade tariffs

The most common tariff is an “ad volorem” rate, where a fixed percentage is levied on imported goods, such as President Trump’s recent move to impose 25% tariffs on all auto imports into the US.

Another type called “specific tariffs” adds a fixed amount charge on each imported good, such as an additional $100 on each foreign-made car. There are also “tariff-rate quotas” where tariffs come into effect when a certain category of goods imported reaches a certain threshold, such as 5,000 vehicles.

While tariffs can provide revenue to the government, they can also be used as a tool to protect local industries and encourage more domestic manufacturing and farming. It can also be used to minimize unfair practices from countries who export artificially cheap goods.

The Trump administration has been using tariffs to negotiate with US trade partners. However, other countries can also retaliate with tariffs on American goods and services, which may weigh on foreign demand and reduce US exports of targeted products.

How tariffs can impact economic growth

Goldman Sachs Research identifies four main channels tariffs can weigh on economic growth. 

1. Consumer prices

First, tariffs can raise consumer prices, leading to a cut in real income. In theory, a tariff hike raises the price level permanently but only spikes the inflation rate temporarily. However, this would only hold true if inflation expectations were well-anchored and consistent, which recent sentiment surveys are signaling to the contrary.

Federal Reserve Chairman Jerome Powell recently said that while tariffs are likely to temporarily raise inflation, it is also possible that “the effects could be more persistent.”

2. Tightening financial conditions

Monetary policies are based, in a large part, on the financial conditions at play within the economy. Central banks assess key indicators like borrowing costs, risk spreads, price volatility, inflation, and exchange rates.

Tariffs tend to tighten financial conditions – and it's already showing.

Financial conditions have tightened more aggressively than what Goldman Sachs Research’s previously expected due to the administration’s announcement of its “reciprocal” tariff and the Chinese government’s announcement of its retaliatory tariffs on US exports. This suggests that the sensitivity of financial conditions to incremental tariffs is rebounding from the moderate levels of early 2025 toward the more outsized levels observed in the 2018-2019 trade war. 

3. Trade policy uncertainty could delay investments

Businesses don’t like uncertainty. The administration’s trade policy swings could cause businesses to delay investment plans until they have a better sense of what policies will actually remain in place. 

4. Narrowing trade deficit

One objective of using tariffs is to address the trade imbalance US has with its trading partners. Goldman Sachs Research believes that narrowing the trade deficit could modestly offset the potential drag on economic growth.

What are the economic tailwinds?

It’s important to remember that not all industries will be affected by tariffs. As for an industry that may face retaliatory tariffs, not all of its producers export their products abroad.

Some countries may ultimately negotiate lower rates or exclusions for certain products (similar to what occurred with China tariffs during the first Trump administration).

Furthermore, our economists believe the impact of tariffs on GDP growth could be slightly counteracted by other aspects of the Trump administration’s agenda – namely, tax cuts and easing of regulations. However, the personal and corporate tax changes that Congress is likely to pass are expected to only modestly boost growth and unlikely to offset the hit from tariffs this year.

Looking ahead on policy

Goldman Sachs Research economists believe the administration will need a large reduction in the tariffs announced on April 2 in order to avoid a US recession this year. That said, the economic outlook remains fluid particularly with respect to the China tariffs and increasing uncertainty for businesses.

In a non-recession scenario, our economists expect the Fed to deliver a package of three consecutive 25 basis point “insurance cuts” starting in June, lowering the fed funds rate to 3.5% - 3.75%.

In a recession scenario, our economists instead expect the Fed to cut by around 200 basis points over the next year.