United States Economic Forecast

Scenarios

Baseline

Our baseline forecast is closest to how we expect the economy to grow based on a set of assumptions made at the time of analysis. Despite recent court rulings regarding particular tariffs,² we expect that the average tariff rate will remain elevated throughout the forecast period, though the country- and product-specific rates are expected to change. As of August 7, the statutory tariff rate was 18.6%.³ However, we assume that this will fall to about 15% by the middle of 2026 as more imports from Canada and Mexico enter the country duty-free. Substitution effects also help lower the average tariff rate.

It’s important to note that the statutory rate is not necessarily the rate faced by importers. In June, the actual average tariff rate was 10% because businesses had built up inventories ahead of tariffs to prevent them from paying higher costs. That strategy only works for a limited time. As inventories are drawn down, we expect the actual average tariff rate to converge toward the statutory rate.   

We also assume that net migration into the United States is lower than previously forecasted. In January, the Congressional Budget Office had anticipated that net migration into the United States from 2025 through 2030 would amount to 6.8 million adults.⁴ We have instead assumed that net migration would accumulate to just 3.3 million adults over that period, based on recent trends in immigration statistics.⁵ This puts downward pressure on the forecast, as there are fewer workers in the country to contribute to economic output. The lost output accumulates, making growth weaker over longer time horizons.

Regardless of whether artificial intelligence creates strong productivity gains, it is already having a sizable effect on business investment growth.⁶ In the baseline, we assume that business investment in AI remains strong despite headwinds from other areas of the economy. Typically, rising inflation, higher interest rates, and slower aggregate growth would create a sharp drop in business investment. However, we assume AI-related investment to remain relatively, though not entirely, impervious to these headwinds.

In this scenario, high tariffs become more evident in consumer prices, raising the core personal consumption expenditures price index to 3.3% in 2026, up from 2.8% in 2024. Despite higher inflation, wage growth moderates, eroding purchasing power and consumer spending. In addition, weaker population growth from a sharp drop in net migration weighs on aggregate consumer spending. As a result, real consumer spending slows to 1.4% in 2026, down from an anticipated 2.1% in 2025. The unemployment rate rises to 4.5% in 2026, up from 4% in 2024.

Despite the slowdown in consumer spending, business investment remains strong as companies continue to pour money into AI-related investments. Even with the headwinds expected next year, real business investment is expected to grow by 3% before accelerating to 4.4% in 2028. Even so, real gross domestic product is expected to slow to 1.4% in 2026 from 1.8% in 2025. Growth is then expected to rebound above 2% in 2027 before slipping back below 2% through 2030.

Downside: More tariffs, fewer people

Our downside scenario assumes a larger rise in tariffs relative to our baseline. We assume that the average tariff rate rises to about 20%, as products such as pharmaceuticals and semiconductors that are currently undergoing Section 232 investigations in the United States⁷ are ultimately tariffed. We also assume that net migration falls to zero from 2026 through 2030. This could come from fewer entrants into the country as well as an increase in deportations. Finally, we assume that the Fed makes a policy mistake by lowering rates too quickly. Given the economic environment where inflation and unemployment are rising, we assume the Fed sets monetary policy to accommodate unemployment, which then results in higher inflation and a corresponding correction to policy.

Higher tariffs result in stronger inflation under this scenario. The personal consumption expenditures price index rises at the same pace as the baseline until 2026, when more of the tariff costs are passed on to consumers. At the same time, the Fed continues to cut interest rates, expecting that inflation will be temporary. The combination of tariffs and looser monetary policy causes inflation to accelerate through the end of 2026. We assume the Fed responds by raising interest rates modestly in the second half of 2026. As inflation comes down, the Fed is able to cut rates at the start of 2027.

Given the higher inflation and interest rates, the economy enters a recession in the fourth quarter of 2026 and comes out of it in the second half of 2027 as the Fed provides more accommodation and inflation begins to subside. Output does not return to its previous high until the first quarter of 2028. The unemployment rate averages 5% in 2027, up from 4.2% in 2025. Weaker immigration also weighs on real GDP and employment growth.

Business investment follows the baseline scenario as AI-related spending remains strong despite higher costs and weakening demand. However, by the second half of 2026, as inflation moves higher and interest rates climb, business investment slows and ultimately declines by 2.3% in 2027. As interest rates, inflation, and unemployment ease, business investment rebounds quickly in 2028.

Upside: More people, fewer tariffs

The upside scenario assumes that the tariff rate falls to about 7.5% by the end of 2026. We assume that Canada and Mexico are able to secure favorable trade deals by the second half of 2026 under a revised United States–Mexico–Canada Agreement. In addition, we assume that product exemptions, court rulings, and additional trade deals lower the average tariff rate further. We also assume that net migration is stronger than in the baseline, lifting the adult population by about 1.4 million people by 2030 relative to the baseline.  

Despite much lower tariffs, the US economy is still expected to grow at a slower rate in 2025 compared with the previous two years. It is not until 2026 that the effect of the difference in tariff rates shows up more clearly in the inflation data. Softer inflation gives consumers more purchasing power. In addition, strong immigration puts upward pressure on aggregate demand. This allows real consumer spending to grow by 1.9% in 2026, only modestly lower than the 2.1% expected in 2025.

With lower tariffs and inflation, the Fed is able to take a more dovish approach to monetary policy. We assume the Fed cuts rates by 25 basis points each quarter from the third quarter of 2025 through the first quarter of 2026. Following this, the Fed lowers rates more steeply in the second and third quarters of 2026, such that the average federal funds rate reaches its neutral 3.125% a quarter sooner compared to the baseline.

The yield on the 10-year Treasury is expected to be lower in the upside scenario as compared to the baseline as investors see inflationary pressures easing and the Fed adopting a more dovish monetary policy stance as a result. The 10-year Treasury yield will ease consistently between the third quarter of 2025 and the first quarter of 2027, to settle at 4.1% from the second quarter of 2027 through the end of 2030.

Business investment is expected to remain relatively strong throughout the forecast period. AI-related spending is expected to continue to fuel business investment in the next few years. With lower interest rates, stronger economic growth, and fewer tariff-related costs, business investment continues to accelerate, maintaining stronger growth in 2026 and 2027 compared to the baseline. Real business fixed investment is expected to grow 3.4% in 2026 and 4.4% in 2027.

Housing

Long-term interest rates have been elevated this year, with the 30-year Treasury yield remaining above 4.8% since August 5. The 30-year fixed mortgage rate has moved lower, falling just below 6.7% on September 2, down from 7% in May. The recent drop in mortgage rates likely encouraged more residential investment in July. However, the mortgage rate is still quite high given current rates of inflation and economic growth.  

Housing starts were up 12.9% from a year earlier in July. Much of this growth was due to base effects, and the outlook for residential investment remains weak amid elevated mortgage rates. For example, residential building permits, a leading indicator of housing starts, were down 5.2% year over year in July. Housing starts have never returned to their peak levels from before the global financial crisis of 2008 to 2009. The long-term failure to build enough homes has contributed to the lack of inventory and elevated prices we see today in some parts of the country. We may have to wait for rates to drop to see a significant uptick in housing construction.

We expect housing starts to fall through the first quarter of 2026 before rising again in the second half of the year. Overall, we expect housing starts to fall to 1.31 million in 2025 and to 1.27 million in 2026. Thereafter, we anticipate housing starts to rise through 2029 as the Federal Open Market Committee cuts rates further. From 2027 through 2029, we expect the housing stock to rise more rapidly than the total population, but housing starts are expected to drop again in 2030 as demographics restrain residential investment.

Although the supply of new housing growth is expected to fall over the next few quarters, demand for housing is also expected to wane. As a result, home price appreciation will remain subdued into 2027. We expect the benchmark home price index to rise by 2.3% in 2025 and by just 1.4% in 2026. In the outer years of the forecast, the home price index is expected to rise by about 4%.

Business investment

Investment is spending that helps grow the long-term productive capacity of the economy and is, therefore, one of the most important indicators of an economy’s future potential. Investment often follows a cyclical pattern, driven by commodity price booms and economic cycles. It can also be incentivized by policies like lower taxes or subsidies for investment.

Business confidence is a crucial determinant of the level of investment growth, as businesses need to feel positive about their future potential to justify spending to grow their operations. Surveys of business sentiment are sending mixed signals. For example, the National Federation of Independent Business small business optimism index was up 10.6% from a year earlier in August.⁹ However, plans for capital expenditures remain well below where they were at the end of 2024. Regional Federal Reserve Bank surveys also point to a mixed picture for capital expenditures in the months ahead.¹⁰

Interest rates also influence investment. Corporate borrowing rates increased along with inflation into 2023. Since then, rates have mostly moved sideways, though they have declined a little since May. Many firms still have more cash on hand than they did before the pandemic, and they can consequently avoid borrowing at elevated rates.

After posting an 8.9% decline in the second quarter of 2025, we predict investment in structures will continue to fall, albeit more modestly, through the end of the year. Overall, we predict investment in structures will fall 2.4% in 2025 and grow 1.8% in 2026.

Besides structures construction, other types of business investment include spending on machinery and equipment, such as computers or industrial equipment, and on intellectual property, such as software. Businesses accelerated their purchases of equipment in the first half of 2025 in anticipation of tariffs. Real spending on equipment grew 24.7% (at annual rates) in the first quarter of 2025 compared with the previous quarter, and another 7.4% in the second quarter.

Frontloading purchases was not the only reason for such strong growth. Investment in equipment to power data centers, as demand for AI surges, also contributed significantly to this growth.¹¹ Similarly, investment in intellectual property products surged 12.8% (at annual rates) between the first and second quarters of 2025. Investment in AI-related software likely drove much of the increase. We expect both categories of investment to remain relatively strong as businesses push through the headwinds of high tariffs, elevated interest rates, and weakening demand. Our forecast shows machinery and equipment investment rising 7.3% in 2025 and 4% in 2026. We see intellectual property spending rising 3.8% in 2025 and 4.5% in 2026.

The resumption of bonus depreciation,¹² which had been gradually phased out under the Tax Cuts and Jobs Act, is expected to support investment spending beginning next year. However, higher tariffs and interest rates restrain growth in the near term. Overall, in 2025, we predict business investment to rise 3.6%, about the same growth rate recorded in 2024. Weakening economic growth amid rising inflation will temporarily slow the pace of business investment growth to 3% in 2026.

Foreign trade

Foreign trade remains the sector with the biggest question marks surrounding it. The tariff landscape is evolving quickly. On August 29, a US appeals court upheld a lower court’s ruling that certain tariffs issued under the International Emergency Economic Powers Act were illegal. The Supreme Court will hear arguments in the case beginning November 5, 2025.¹³ Thus, the future path of tariffs and trade policy remains highly uncertain. Given the difficulty of predicting the specific package of tariffs that will be introduced or the possible duration of time they will remain in force, we have built our forecast around the potential increase in the average effective tariff rate, rather than a specific selection of imports.

In our baseline scenario, we raised the average tariff rate on goods imports by 12.5 percentage points, from approximately 2.5% at the start of this year to 15%. This level of tariffs is slightly below the 18.6% statutory rate as of August 7. We assume that the average effective tariff rate is lower than the statutory rate because buyers can substitute away from the most affected goods and because numerous products are exempt from tariffs. In addition, we expect a rising share of imports from Canada and Mexico to enter the United States duty-free as they officially become compliant with the United States–Mexico–Canada Agreement.

The imposition of these tariffs is likely to turn into a complicated process, with individuals and businesses trying to make substitution and supply chain decisions based on new relative prices. As elevated tariffs remain in place, we expect growth in exports and imports to be 0.6% and 3.1% in 2025, respectively. Import growth for this year as a whole is flattered by a surge in imports at the start of the year in anticipation of looming tariffs. Trade growth slows more dramatically in 2026, with exports growing 0.3% and imports falling 0.3%.

It may be surprising to see that exports may decrease due to higher tariffs. There are a few reasons why this is the case in the short term and why tariffs may have unanticipated impacts in the long run. First, about half of imports are currently used as intermediate inputs by US businesses. It will likely take some time for US producers to find local alternatives to the goods they are currently importing, and in the meantime, their cost of doing business will rise. This dynamic could reduce the money available to firms to invest and may drive some US producers out of business if the costs are not passed on to consumers. It will also make their exports costlier and less competitive. Tariffs will shield US producers from the import competition required to make globally competitive products. So, while they may dominate the US economy, they are also likely to lose export sales,¹⁴ leading to limited net gains for American manufacturing.

Many of the potential benefits of tariffs could take much longer than five years to be realized and therefore do not occur within our forecast horizon. In most industries, there is not a large pool of American manufacturing production currently staffed but sitting idle. Factories will need to be built, and workers hired and trained, both of which will take time. When there are few US-alternative goods, the cost of tariffs is likely to be borne primarily by American households and businesses. Higher import costs can also deter the reshoring of production. In many cases, the reason for offshoring has as much to do with the availability of certain skills as with cost, and reshoring all this production will require major skills-training programs to ensure an adequate supply of workers. A significant drop in immigration will only make this challenge more difficult and time-consuming.

Government policy

The administration enacted new tax legislation, commonly referred to as the One Big Beautiful Bill Act, which includes changes to federal tax and spending laws. The Congressional Budget Office (CBO) estimates that the bill would add about US$3.4 trillion to the federal deficit over the next 10 years, excluding debt service and macroeconomic effects.¹⁵ The CBO also projects that adding in debt service costs would bring the total cost of the bill to US$4.1 trillion over the same period. Most of that rise in the deficit will occur early in their 10-year forecast window. For example, just over US$1 trillion would be added to the deficit in 2026 and 2027 alone.

Some of the largest tax cuts in the bill include an extension of the expiring tax provisions in the Tax Cuts and Jobs Act and the elimination of taxes on overtime and tipped income. To offset these tax reductions within the budget window, savings come from repealing and modifying certain tax credits enacted under the Inflation Reduction Act and from cutting expenditures on Medicaid and food assistance programs.

Although the increase in the deficit is expected to be substantial, the economic effects are more limited. Much of the cost of the budget bill is spent on extending tax provisions that are already in place. Extending those provisions creates neither a stimulative nor a contractionary effect. After removing those provisions, we find that the direct effect of the bill would only raise economic growth through 2026 before it becomes increasingly contractionary through the end of the forecast period.

In addition to the budget bill, trade policy will also generate revenues. There is substantial uncertainty over how much revenue these tariffs will generate. The CBO estimates that tariff revenue could amount to US$4 trillion through 2035.¹⁶ However, the Yale Budget Lab estimates that tariffs will generate just US$2.2 trillion over the same period after accounting for dynamic effects.¹⁷ Using our baseline assumptions for tariffs and immigration, we estimate that tariffs would create about US$2.5 trillion in revenue over the next decade.

On the spending side, federal government employment has been declining since January 2025. We expect federal government employment to remain below its previous peak for the duration of the forecast. Incorporating all of these factors, plus debt service costs and economic effects, we find that the federal budget deficit will rise to 6.9% of GDP in 2027 from 6% in 2025. The deficit will narrow to 6.5% for the rest of the forecast period.

Labor market

The labor market has weakened since April. Average monthly nonfarm payroll gains were just 30,000 during the three months through August 2025, far below the average gain of 168,000 in 2024. Most of the recent payroll gains have been concentrated in health care and social assistance. On the upside, the unemployment rate remained at a relatively low 4.3% in August, just 0.1 percentage point higher than a year earlier.

Given the recent data that shows immigration has plummeted this year, we have adjusted demographics accordingly. For example, we now assume that net migration amounts to just 3.3 million adults through 2030, down from 6.8 million estimated by the CBO in January.¹⁸ Our baseline for net migration comprises merely estimates. The latest immigration data is incomplete, and we recognize that immigration patterns could change substantially over the next five years.

The negative effects on the economy accumulate over time. Historically, new migrants take time to join the labor force,¹⁹ so previous waves of immigration support labor force growth in subsequent years, blunting the negative effects of the drop in net migration in the near term. Weaker labor force growth lowers both employment growth and the labor force participation rate. The participation rate slips a little because immigrants typically have higher participation rates than their native-born counterparts. However, this also pushes the unemployment rate slightly lower than the counterfactual despite weaker overall employment growth. 

We expect job growth to turn modestly negative through the first quarter of 2026 as high tariffs, weaker immigration, and elevated interest rates restrain demand for labor. Federal government employment will see the sharpest decline, but private sector employment growth is also expected to moderate into next year. We expect the unemployment rate to rise from 4.2% to an average of 4.5% in 2026 before declining toward 3.9% in 2030.

Financial markets

Stock markets have shown considerable strength despite the headwinds to economic growth. Equity prices initially plummeted when “reciprocal tariffs” were announced on April 2. However, since then, stock prices have rebounded strongly. As of this writing, the S&P 500 stock price index was about 6% higher than its peak at the end of February 2025.²⁰

While equity markets have recovered, bond markets have behaved unusually. During financial market stress in April, the yield on US Treasury bonds increased, and the value of the dollar fell. In the past, bond yields typically fell along with the value of the dollar. Since then, yields on longer-term Treasury bonds have remained elevated, and the dollar has remained weak. In addition, the dollar had been expected to appreciate as tariffs were implemented, making the recent downturn particularly unusual.

In our baseline forecast, we maintain a relatively high 10-year Treasury yield. However, we assume it remains between 4.3% and 4.4% through the end of this year, roughly where it has been since May. Although we anticipate short-term interest rates to decline in the next couple of years, long-term interest rates are expected to remain elevated. Notably, we expect the 10-year Treasury yield to remain above 4.1% through 2030.

Since the Federal Open Market Committee (FOMC) began its rate-cutting cycle, it has cut rates worth 100 basis points, bringing the Fed’s target range to between 4.25% and 4.5%. Policymakers are now entering a period of complex choices on interest rates. In our baseline scenario, we think the Fed will make two interest rate cuts before the end of this year to support a weakening economy. Despite higher inflation, we still expect the FOMC to steadily cut the federal funds rate to 3.125% by the fourth quarter of 2026.

In our downside scenario, we explore what would happen if the FOMC lowers rates too quickly. In that case, we assume that the FOMC continues to cut rates at the same pace as in our baseline scenario through the first half of 2026. However, with inflation continuing to rise, the Fed reverses course and raises rates in the second half of 2026 before lowering them again in 2027.

Prices

Headline inflation has started to rise again, with year-over-year consumer price index (CPI) inflation rising to 2.7% in July, the highest reading since February 2025. Similarly, the Fed’s preferred measure of inflation—the personal consumption expenditures deflator—came in at 2.6% year over year in July, moving further away from the Fed’s 2% target. Core inflation, which excludes food and energy prices, has also moved higher. For example, core CPI inflation was 3.1% in July. Still, the Fed likely views some of the inflationary impulse as a temporary phenomenon related to tariffs, which will allow it to cut interest rates even as inflation rises.

The outlook for inflation remains highly uncertain and depends heavily on how much of the tariff cost is passed on to consumers. Already, we are seeing signs of cost pass-through. We assume that about 60% of the tariff cost is passed on to consumers, which is at the lower end of estimates.²¹ This suggests that our forecast may underestimate the inflationary impulse from tariffs. We expect CPI growth to average 2.9% in 2025 and accelerate modestly to 3.2% in 2026. Thereafter, inflation is expected to moderate to about 2.3% in 2030.

In addition to the inflationary impulse from tariffs, inflation expectations could also push inflation higher. Tariffs should result in a one-time upward price adjustment rather than enduring inflation. However, if inflation expectations rise, then inflation could become more entrenched. In July, the New York Fed’s survey of consumer expectations revealed a median one-year-ahead expected inflation rate of 3.1%. That was down from 3.6% in April but up slightly from 3% in January. Other measures have seen more extreme upward movement in inflation expectations. For example, in the University of Michigan’s May survey, one-year-ahead inflation expectations were 4.8% in July, up significantly from 3.3% in January.