Forecast shows trade war bogging down economic growth

If we get stagflation this year — stagnant growth and elevated inflation — it may be short-lived. That's because the "stag" will eventually overpower the "flation."The big picture: If the trade war causes economic activity to slow down and unemployment rises, that slump could be enough to prevent a second-round inflation surge, after the initial tariff hit works its way through prices.Import taxes may prompt companies to raise their prices to adjust. But in an environment of sluggish growth, workers won't be in a position to demand outsize raises, and companies will be unable to hike prices as much as they might like.Driving the news: New forecasts from the Organisation for Economic Co-operation and Development show economic growth buckling under the weight of President Trump's trade war, alongside a temporary surge in inflation.The Paris-based group's forecasts are based on tariff policies from mid-May, including the reduction in tariff rates from the U.S.-China trade truce. Notably, the OECD also based its forecast on the expectation that the 2017 tax cuts will be extended.The group sees the global economy's fate as directly tied to Trump's tariff policies: If tensions ramp up, outcomes will be worse. If trade tensions dissipate, so do their gloomy projections.By the numbers: The worst of the economic pain is concentrated in North America, especially in the U.S.The OECD expects U.S. growth to slow to 1.6% this year, a significant fall from last year's 2.8% growth rate. The economy is expected to continue to slow in 2026.What they're saying: "Annual headline inflation is set to pick up to 3.9% by end‑2025 due to higher import prices but is expected to ease throughout 2026, aided by moderate GDP growth and higher unemployment," the OECD wrote in the report."For most countries, inflation will stay a bit higher for longer ... even though we do think that by the end of '26, they'll be closer to their targets," OECD chief economist Álvaro Santos Pereira told reporters Tuesday morning.State of play: Goldman Sachs economists this week laid out their case for why inflation pressures likely won't linger."The main reason is that we expect the economy to be weak this year, with GDP growing just 1%," they wrote. "We are skeptical about the prospects for prolonged high inflation amidst mediocre economic performance.""But if—contrary to our expectations—country-specific tariffs rise back to prohibitive rates or tariff escalation continues into 2026, we would worry more about high inflation persisting for longer."The intrigue: Most Fed officials so far have been hesitant to take a position on how tariffs will impact the economy. Fed governor Christopher Waller is the exception, with a recent speech underscoring his expectations that tariffs will cause a one-time inflationary bump."[W]hatever the size of the tariffs, I expect the effects on inflation to be temporary, and most apparent in the second half of 2025," Waller said in a speech Sunday in South Korea.Yes, but: Waller is more optimistic and believes that economic demand will persist in the face of tariff-related price boosts, with limited pass-through to consumers.Putting tariff effects aside, he expects underlying inflation to continue to approach 2% and that the labor market will remain solid."I know that hearing 'transitory' will certainly remind many people of the consensus on the FOMC in 2021 that the pandemic increases to inflation would be transitory," Waller said, referring to the Fed's rate-setting committee. "Am I playing with fire by taking this position again? It sure looks like it."

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