New tariffs promise protectionism but deliver inflation and economic slowdown: OECD simulation analyzes at a baseline scenario of 10% tariffs.

The specter of rising trade barriers looms large over the global economy, casting a shadow on the fragile recovery from the COVID-19 pandemic. A recent simulation by the OECD, analyzing the impact of a 10% tariff hike between the United States and its trading partners, paints a stark picture of potential economic disruption. With inflation still a persistent concern and global growth already slowing, these protectionist measures risk exacerbating existing vulnerabilities and triggering a cascade of negative consequences.

Based on the NIGEM and METRO global macroeconomic models, OECD's simulation, reveals a concerning trend: increased tariffs are a recipe for stagflation, a toxic combination of rising prices and stagnant growth. The data unequivocally demonstrates that a 10% tariff increase would fuel inflation across the board. Even regions geographically distant from the US, such as Japan and the Euro area, would see inflationary pressures intensify, albeit to a lesser extent.

A Bleak Outlook

In its latest projections, OECD downgraded its global growth projections for 2025 and 2026 in light of various political and economic uncertainties. Compared to its last outlook, published in December 2024, the OECD revised its global GDP growth projection for 2025 from 3.3% to 3.1% and its 2026 estimate from 3.3% to 3.0%.

Anticipating the headwinds and sharing this concern, the U.S Federal Reserve held interest rates steady, as predicted, but adjusted its economic outlook, raising inflation and unemployment forecasts while lowering GDP projections. The central bank also announced a slower reduction of certain balance sheet assets. U.S. inflation is now expected at 2.7% this year and 2.2% next. Let’s move on to analyze the data from OECD’s simulation.

Inflation Impact

The OECD data paints a concerning picture of the inflationary consequences of these tariff increases (chart below). Over the first three years following implementation, inflation would rise across all major economies, with particularly pronounced effects in North America:

• Canada would experience the highest inflation surge at +0.90 percentage points.

• The United States itself would see inflation rise by +0.70 percentage points.

• Mexico would face a +0.67 percentage point increase.

• Global inflation would tick up by +0.38 percentage points.

These figures are especially troubling given that many economies are still wrestling with inflation hangover from pandemic-era supply chain disruptions and fiscal stimulus measures. The tariffs would effectively introduce a new inflationary shock just as central banks have been working to bring price pressures under control.

GDP Consequences

Perhaps more concerning are the projected GDP impacts by year three. The simulation shows negative growth effects across all measured economies:

• Mexico would suffer the most severe contraction at -1.30%.

• The United States would see GDP reduced by -0.72%.

• Canada would experience a -0.64% drop.

• The global economy would contract by -0.27%.

These figures reflect the fundamental economic reality that tariffs, while often implemented for the pretext of protecting domestic industries, ultimately create broader economic inefficiencies. The data suggests the policy would be particularly counterproductive for the country implementing it, with the US suffering the second-largest GDP decline among all countries analyzed.

Regional Variations: Only Degrees of Loss

What's striking about the OECD projections is that no major economy emerges unscathed. Even China, facing a relatively modest GDP impact of -0.10%, would still experience negative growth effects alongside heightened inflation (+0.31%). The Euro area would see GDP decline by -0.17% while inflation would increase by +0.25%.

The OECD's revised global growth projections reflect these compounding challenges. Using sophisticated economic models, these figures represent a significant downward revision from previous forecasts, suggesting that tariff escalation could derail the fragile post-pandemic recovery.

Policy Recommendations

As policymakers confront this challenging economic outlook, several approaches could help mitigate the negative effects:

⮚ Renewed multilateral engagement: Rather than unilateral tariff actions, reinvigorating international trade forums to address legitimate concerns about trade imbalances would provide more sustainable solutions.

⮚ Targeted industrial policies: Instead of broad tariffs that raise costs for consumers and businesses alike, focused investments in critical industries and worker retraining programs could address competitiveness concerns more effectively.

⮚ Coordinated monetary policy: Central banks will need to carefully calibrate their responses to potential tariff-induced inflation, avoiding over-tightening that could compound GDP losses.

⮚ Supply chain resilience initiatives: Policies that encourage supply chain diversification without resorting to protectionism could enhance economic security while minimizing inflationary impacts.

Trouble Ahead?

The OECD simulation paints a sobering picture of the global economy under the weight of U.S. tariffs. As the world grapples with the lingering effects of the COVID-19 pandemic, trade barriers are a step in the wrong direction, threatening to deepen economic woes rather than resolve them. Policymakers have a narrow window to act. By prioritizing cooperation over confrontation, balancing monetary and fiscal policies, and investing in resilience, they can steer the global economy away from the dark clouds gathering on the horizon.

Originally published on Substack.