“U.S. Economic Growth Expected to Flatline in 2025. Tariffs Are the Main Reason.” – Barron’s (April 15, 2025) (Photo by Library of Congress/Interim Archives/Getty Images) Getty Images “If they don’t change the tariffs, it’s going to be an extinction-level, asteroid-wiping-out-the-dinosaurs kind of event… a $2T hit to economic activity in our country, the failure of tens of thousands of American businesses, and the laying off of millions of employees…” – Ryan Petersen, CEO of Flexport, a leading logistics company – from The Wall Street Journal (May 2, 2025) The Trade War is on. Will there be a Recession? Yes. Without a doubt. At some point, the business cycle will turn down. As night follows day. But – I don’t think that tariff policies will be the cause of it. MORE FOR YOU Executive Summary The causal pathways that could lead from potential tariff hikes to negative growth are not (yet) showing signs of activation. There are four “channels” that could transmit the tariff shock to the larger economy: Reduced demand due to higher prices (similar to any tax) Supply-chain disruptions and lost output A crisis of business confidence, leading to lower investment and hiring Increased negative sentiment among consumers, leading to lower spending The case for alternative 1 seems insufficient. The direct monetary impact of a tariff tax appears to be simply too small to derail a $30+ trillion dollar economy with four years of strong upward momentum. As for alternative 2, recent history shows that supply chain stress does not necessarily cause a slowdown. The U.S. economic surge in growth that began in Q4 2020 happened despite high levels of supply chain pressure throughout 2021 and 2022. Alternatives 3 and 4 are psychological in nature - which makes them harder to evaluate. Will the continuing uncertainty surrounding tariff policy lead to a crisis of confidence among businessmen and/or consumers? Will businesses stop investing? Will consumers cut spending, sucking demand out of the economy? Perhaps. It is the most credible risk scenario. But psychology has yet to translate into concrete behavior. So far we have not seen the typical signs of a slowdown. If anything, growth signals have strengthened over the past two months. Most forecasts are now downplaying the possibility of a recession in the next 12 months. Tariff Jitters The apprehension over tariffs is real. All Spring, and now into the Summer, the Risk-On/Risk-Off cycles in the financial markets have run in sync with the Tariff-On/Tariff-Off trade policy pronouncements coming out of Washington. The prospect of a new American protectionism – the likes of which has not been seen for a century – has created large and multidimensional uncertainties. Will higher tariffs lead to inflation? Will they poison the Treasury Bond market, and exacerbate the deficit? Will they provoke a trade war with Europe and weaken the Atlantic alliance? Time has quelled some of these worries. Inflation is declining. The bond markets have calmed down. The VIX is 20% below its long-term average. And Europe seems to be constructively engaged. At least for now. Return to Normal Chart by author But as we pass the original July 9 deadline for the end of the 90-day “pause” on new tariffs – now extended to August 1 – the biggest question of all is back on the table: Will higher tariffs cause a Recession? April was the Cruelest Month At first, it seemed so. “Liberation Day” (April 2) produced panic in the forecasting profession. The Wall Street Journal Street surveyed 64 prominent economists two weeks later. Their estimate of the probability of a recession jumped from 21% in January to 46% in mid-April. Likelihood of a Recession in the Next 12 Months (April 2025) Chart by author Even if the technical criteria for a recession might not be met, most forecasts projected a significant tariff-induced slowdown. Economists surveyed by Bloomberg expect real GDP to grow by 1.4% this year [down from 2.8% growth in 2024]. The Peterson Institute for International Economics sees average annualized growth of only 0.1% for the year. Torsten Sløk, chief economist for Apollo, was convinced: “Tariffs have been implemented in a way that has not been effective, and there is now a 90% chance of what can be called a Voluntary Trade Reset Recession.” Barron’s “Big Money” poll of top money managers found that 43% of respondents cited “recession” or “slowdown” as the biggest risk in the next 6 months, compared to just 11% for “inflation.” The Atlanta Federal Reserve’s macroeconomic model GDPNow – a “realtime” model of economic growth – immediately dropped its forecast for the 2nd quarter GDP growth rate from 2.5% to 1%. The consensus outlook according to leading economists surveyed by Blue Chip Economic Indicators called for growth of less than 1%, with many expecting an outright contraction of the economy – that is, a recession. Recession Forecasts - Bluechip Forecasts vs Atlantic GDPNow model - April Chart by Stlantia Federal Reserve All in all, the professional view in April was pessimistic. The effect of the proposed tariffs was seen as clearly negative. The Economists’ Confusion What was the logic of this pessimism? Let us start at a high level. Viewed from the most general macroeconomic perspective, the effect of a tariff on domestic economic growth should be more or less neutral, leaning positive in principle. “A tariff is an expansionary policy. It diverts demand from foreign to home producers.” – Peter Temin, Lessons From The Great Depression, p. 46 “A tariff on final goods shifts expenditures toward domestically produced goods; it constitutes a positive demand shock.” – The Center for Economic Policy Research (CEPR), a UK think tank (July 9, 2025) In other words, a tariff does not make consumers’ demand disappear. The business goes to domestic companies instead of foreign suppliers. Which should be stimulative. But other effects point in the opposite direction. “In contrast, a tariff on raw materials or intermediate goods increases costs for domestic producers; it constitutes a negative supply shock.” (CEPR) This brings to mind a “mango” parable, which goes like this: The U.S. does not produce mangos. Therefore a domestic producer of, say, mango ice cream will have an unavoidable increase in cost, which will mean lower profits or lower sales (because demand for ice cream is price-elastic). Which would be contractionary. An Indian labourer unloads mangoes at the Gaddiannaram fruit market in Kothapet, located in the ... More outskirts of Hyderabad, on April 18, 2009. Mangoes are indigenous to the Indian subcontinent, where India produces nearly half of the world's production of the fruit. AFP PHOTO / Noah SEELAM (Photo credit should read NOAH SEELAM/AFP via Getty Images) AFP via Getty Images Some studies, and some models, conclude that the negative supply shock on intermediate goods will outweigh the positive demand shock for final goods. Then there are “frictions” and “inefficiencies” –economists’ classic caveat – that are also said to push the calculation back to a net negative. However, not every input is a domestically unsourceable mango. Many producers may be able to shift to domestic sources for their inputs – in fact, this is exactly what a tariff encourages them to do. At least some import-substitution will take place, so the net-net again should be more business for domestic suppliers — i.e., expansionary. There is also the larger context including fiscal and monetary policy responses. Tax reductions or interest rate reductions may offset or reverse any negative growth impact. “Is a tariff expansionary or contractionary? The answer depends on how monetary policy responds… If the central bank prioritizes price stability, the tariff will lead to a sharp short-run contraction. Alternatively, the central bank can offset this contraction by pursuing an expansionary response.” – National Bureau of Economic Research (May 2025) And finally there are factors that typically lie outside the economists’ models or are captured only very imperfectly, such as business confidence or stock market psychology, or general consumer sentiment. In the immediate aftermath of Liberation Day, violent stock market gyrations drove the markets crazy. Sudden and deep daily declines created a sharp (though brief) reversal of the “wealth effect” – the sense of financial well-being that comes from a stable and rising stock market boosting the nominal value of people’s portfolios. Consumers are said to react to such reversals by cutting back on spending, while increasing saving – which would be contractionary. Following the tariff flurry, consumer spending did drop somewhat, though the rate of growth remained above the pre-pandemic average. Personal savings rate spiked from 3.5% at the end of 2024 to 4.9% in April 2025, before falling back in May. The spike in forecasters’ negativity was undoubtedly driven by such factors to a significant extent. But markets have calmed down and in fact have surged ahead to new record highs (more on that below). In short, as with many pressing questions related to tariff policy, there is no coherent and unbiased economic consensus. But let us try to summarize the framework for thinking about how tariffs could cause a recession, relying on general causal arguments rather than the esoteric paraphernalia of academic economic models. The Mechanics of a Tariff-Induced Recession There are four pathways or “channels” by which a tariff increase could lead to an economic slowdown or recession. 1. The “Tariff Tax” Channel This is the argument that a tariff forces people to pay more for what they buy, reducing their purchasing power, and thus subtracting demand from the economy. If I must have mangoes, and I have to pay more for my now heavily-tariffed mangoes, I will have less money to spend on other things – which means that the producers of those other things will see less of my business. They will experience reduced profits, leading them perhaps to cut back and lay people off. In the aggregate, lost demand means lower growth. Counterarguments There are a number of problems with this logic. The impact of tariffs is transitory, and quite small relative to the size of the economy. Tariff revenues this year are estimated at $300 Bn – less than 1% of the U.S. annual GDP. (Estimates of the tariff impact derived from various academic macroeconomic modes, similar in scope, are described in my previous column, here.) Models of the impact of tariffs mostly ignore the ways in which economic agents (consumers, producers, regulators) would respond to tariffs by adjusting their behavior, through substitution, shifts in demand, and other measures which mitigate the negative consequences (also described in the previous column). If I decide to cut back on how many mangoes I eat, or if I choose to eat Georgia peaches instead, my overall purchasing power is unaffected. Policy changes may offset the tariff impact. For example, if the government applies tariff revenues to reduce the federal debt that would be contractionary; but if the tariff revenues are used to justify lower taxes, the negative impact may be cushioned or eliminated. Overall, it seems unlikely that a “tax-like” reduction in purchasing power which is small (relative to the size of the economy) and which can be mitigated either by consumers themselves or by government policies would be enough by itself to drive a robust economy into full-blown recession. 2. The “Supply Chain Stress” Channel According to this argument, tariffs disrupt global supply chains, causing distortions, dislocations, bottlenecks and shortages which will drive up inflation beyond the “tariff-tax” effect and lead to “inefficiencies” and “lost output.” “By distorting consumption and production decisions, tariffs generate efficiency losses that lower the economy’s potential output. Together, these effects amount to a “supply shock” that raise the specter of slower growth alongside rising inflation—in other words, a stagflation scenario.” – National Bureau of Economic Research (May 2025) Counterarguments The Pandemic shock in 2020 created disruptions far more severe than anything that tariffs are likely to produce. The chart here tells the story. The left-scale shows the New York Fed’s index of Global Supply Chain Pressure (GSCPI). The right-scale shows the changes in Real GDP. Supply Chain Stress in the Pandemic Chart by author Observations: the pandemic shock produced a surge in the GSCPI and a brief drop in GDP lasting three quarters (Q2-4 2020) Growth resumed in Q1 2021 even though supply chain stress was still increasing Supply chain stress was very elevated (3 standard deviations above the long-term average) from Jan 2021 until August 2022, but the economy expanded at an average annual rate of 5.3% over that time period Unlike the immediate spike in the GSCPI in Q2 2020, the index of supply chain stress has not increased significantly since Liberation Day In short, it does not appear that this factor alone will be sufficient to drive the economy into a recession. 3. The Business Uncertainty Channel John Maynard Keynes blamed the lack of business confidence – he called it a loss of “animal spirits” – for the economic downturn of the 1930s. If today’s drum roll of Tariff-On/Tariff-Off pronouncements – a “stop-start trade war” as the Wall Street Journal called it – has undermined business confidence, it could have a negative impact on hiring and investment. Initial reactions were apprehensive. “Corporate America Is Leaving More Jobs Unfilled: Most employers aren’t laying off workers, but many will pause hiring while the trade war plays out.” – WSJ (May 4, 2025) “Tariffs have caused things to come to a standstill. It makes it tough to have confidence, and confidence is fuel for the economy, so a recession is more likely than not.” – a professional asset manager cited in Barron’s (May 2, 2025) “CEO Confidence collapsed in Q2 2025 after surging in Q1,” said Stephanie Guichard, Senior Economist, Global Indicators, The Conference Board. Counterarguments? It is not clear that apprehension translates yet into actions that would lead towards a recession or a slowdown. First quarter domestic investment was up significantly (+26% year over year). Some measures of capital spending show slight downward trends since March, but there is a lag in data availability which clouds the issue. Sentiment soured in Q1 2025, but Capital goods spending remained strong. Business Confidence and Capital Goods Investments Chart by Conference Board Hiring continues reasonably steady, with 147,000 jobs added in June. Q2 2025 averaged 150,000 jobs added per month compared to 110,000 per month for Q1. Following Liberation Day, surveys of executives certainly show pessimism. But note the highlighted nuances in the Conference Board’s report. “The vast majority of CEOs (83%) said they expect a recession in the next 12-18 months, nearly matching the percentage who feared recession in late 2022 and early 2023. That earlier recession never materialized. There may be a bias built into these survey responses. “The US–China trade deal announced on May 12 seems to have eased concerns… CEOs who responded after May 12 tended to be somewhat less pessimistic about the future and fewer expected a deep recession.” A good example of Tariff-Off = Risk Off? While there is uneasiness in the private sector, it has not evolved into a sustained “crisis of confidence.” Business leaders may be evolving past the “shock phase” and returning to a more balanced perspective. 4. The Consumer Confidence Channel Consumer sentiment has also declined. The Conference Board reported that “Consumer confidence weakened in June, erasing almost half of May’s sharp gains… “The Conference Board Consumer Confidence Index deteriorated by 5.4 points in June… "The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—fell 6.4 points… "The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—fell 4.6 points to 69.0, substantially below the threshold of 80 that typically signals a recession ahead.” Declining consumer sentiment could result in reduced spending and increased savings behavior — invoking the famous “paradox of thrift” that would suck demand out of the system. Counterarguments Consumer sentiment is always volatile. Following a big drop in April, a rebound in May was the largest upswing in several years. Nevertheless, consumers tend to be pessimistic, with two-thirds to three quarters of those surveyed by the Conference Board predicting a recession every month over the past four years. The Michigan Consumer Sentiment Index shows that public psychology has not recovered from the Pandemic shock. Consumer Psychology Altered By The Pandemic Chart bu author Aside from sentiment, trends in actual consumer behavior — spending and saving – are inconclusive. Retail spending did decline in May, though not much (the rate of spending growth eased about half a percent, about equal with the January 2024. level). And the savings rate fell. (By comparison, when the Pandemic hit in 2020, consumers immediately cut spending by 14% in one month, and the savings rate jumped from 7% to 32%. That is what a true loss of consumer confidence looks like.) In short, people today may be worried, may say they are worried, but they are not yet acting worried. Reality Sets In “Market volatility eases and stocks soar as investors ignore Trump tariff threats” – The Financial Times (July 11, 2025) In my opinion, the “confidence” channels are the principal drivers of recessionary tendencies in the modern economy. Most of the tecniques of countercyclical policy have been figured out. Central banks now generally know when to stimulate and when to withdraw stimulus, even if they are sometimes tardy about it. What is not so easy to control is the psychological dimension. George Selgin has written a terrific new book (False Dawn: The New Deal and the Promise of Recovery) on the government’s efforts to wrench the U.S. out of the Depression, which shines a light on the antagonism between the Roosevelt administration and the private sector as a major factor in explaining the slow and fitful recovery. “By the mid-1930’s, New Deal policies and rhetoric had given businessmen ample reason to be apprehensive about the future…arising from antibusiness rhetoric, micro-interference, sometimes punitive taxes, and continuous, often disconcerting experimentation…. What finally ended the Great Depression? [It was] the reawakening of private business investment from its slumber that lasted for a decade and a half.” The parallels with our current situation are not far-fetched. Tariff threats and retractions have rattled the cage hard, spiking up uncertainty and volatility – two things that traders may love, but businessmen hate. If there is a tariff-related mechanism in the economy that could generate a recession, it is probably along the lines of “continuous, often disconcerting experimentation” by the policy-makers, frightening consumers into pulling back from spending, and paralyzing business investment, rather than some incremental price penalty at the margin. But so far, despite intermittent sour moods, neither the business community nor the public have reined in their spending. Gross Private Domestic Investment grew by 5.8% in Q1 compared to the previous quarter – the most since Q4 2021. Q 1 2025 Gain in Private Sector Investment Chart by author Meanwhile, the tenor among forecasting professionals has turned positive. A late June WSJ headline read “U.S. Economy Shrugs Off Trade War and Soldiers On: Employers and investors braced for economic meltdown. It hasn’t happened.” The stock market recovered its April losses and began pounding out new record highs. The S&P 500 Index has gained 27% in the last 100 days, its most vigorous rally in five years. Torsten Sløk modified his “90% recession probability” view to the upside, now projecting just a 0.8% reduction in GDP – not enough to trigger a recession. The Atlanta Fed Forecast had also brightened considerably. The GDP estimate for Q2 spiked up about 4% in May and settled to about 2.5% by the end of June. The so-called Blue Chip consensus also moved back up to project a healthy 2% GDP growth rate. Recession Forecasts - Bluechip Forecasts vs Atlantic GDPNow model - July Chart by the Atlanta Federal Reserve And right on time, economists have started to regain their confidence. The Wall Street Journal’s July survey found that 2/3rds of those surveyed see no recession in the next 12 months. The Wisdom of Crowds… Two other data-sets point also to a normalization of the tariff threats. Immediately following Liberation Day, prediction markets like Kalshi and Polymarket reflected the general panic, and the betting consensus for a recession this year soared to 66%. Today, however, the odds of a recession are less than 20%., Polymarket Predictions of Recession Probabilties This Year Chart by author The other source for crowd wisdom is the financial market itself. Aside from the general rise in share prices (hitting an all-time high last week), earnings forecasts for the next 12 months have accelerated sharply since early May. This is clearly inconsistent with a recession scenario. Earnings Forecasts Chart by Torsten Sløk, Apollo A Tentative Conclusion? Professional forecasters have been overly pessimistic for several years, consistently underestimating GDP growth. They are now catching up to events. Paradoxically, expert forecasts are looking like a lagging indicator – at best. Meanwhile, the real agents in the economy are simply not behaving in a pre-recessionary way. Consumers as always remain pessimistic — but they keep on spending. Employers are worried, but they keep on hiring. The standard indicators are inconclusive, at best. It does not appear that the 3rd and 4th causal concepts described above — business confidence and consumer sentiment – are currently generating a recessionary trend. In any case, the asteroid-alert can be called off. Further reading – ForbesAbout Tariffs – Part 1: The CertaintiesBy George CalhounForbesTariff Uncertainties – Part 2: The Link To InflationBy George CalhounForbesTariff Uncertainties, Part 3: The Bond MarketsBy George CalhounForbesTariff Uncertainties, Part 4: A Little Q&A (Trump, Trade, China)By George Calhoun Editorial StandardsReprints & Permissions