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Chart 1 provides an update to our three scenarios:

1. The optimistic scenario assumes that the administration rolls back a good portion of the tariffs announced on April 2. Tariffs peak at their highest level since the 1940s.
2. The baseline forecast assumes that tariffs hit their highest level since the early 1900s. Countries are guarded in their retaliation.
3. The pessimistic scenario assumes that the current tariff announcements hold. Tariffs trigger a more consequential trade war with multiple countries.

Optimistic scenario:

• Growth slips below the economy’s potential of just under 2% but skirts a recession.
• Unemployment rises to 4.9% by year-end, 0.7 percentage points higher than in March.
• The Fed’s preferred inflation measure â€� the core personal consumption expenditures (PCE) price index â€� peaks at 3.8% in the third quarter.
• The Fed starts cutting rates in the fourth quarter of 2025 as inflation starts to abate.

Baseline forecast:

• The economy slips into a mild recession for three quarters, starting in the second quarter.
• The unemployment rate rises to 5.2% by year-end, one percentage point above the March level.
• Core PCE inflation peaks at 4.8% in the third quarter; that is two full percentage points above its February 2025 pace.
• The Fed holds off on rate cuts until the fourth quarter, despite the weakness in the economy; its goal is to avoid the mistakes made in dealing with the post-pandemic inflation.

Pessimistic scenario:

• The economy slips into a much deeper recession.
• Unemployment hits 5.8% by year-end, 1.6 percentage-points higher than in March.
• Core PCE inflation peaks at 4.8%, the same as the baseline, but recedes more rapidly.
• The Fed begins cutting rates in May, but for all the wrong reasons - a deeper, more scarring recession.

Risks. Members of Congress are beginning to feel the ire of their constituents over the president’s agenda. That has prompted some Republicans to team with Democrats to try curb the president’s power to levy tariffs. They lack support in the House of Representatives, and the super majority needed to overturn a veto.

A deeper recession and financial crisis cannot be ruled out if tariffs are not rolled back. Trade wars are nonlinear and are easier to prevent than end.

3) Boost inflation. The April 2 tariffs are significantly larger than anything the president levied during his first term. They will cascade through supply chains and raise costs, much of which will be passed along to consumers.

Chart 3 shows the inflation forecast under the three scenarios. Inflation picks up in all three but is more consequential in our baseline forecast.

Weaker demand and falling commodity prices will blunt the boost to inflation due to tariffs. Another mitigating factor could be a strong dollar. Tariffs typically trigger an appreciation in the value of the dollar.

Thus far, that has not occurred. Fears of recession are forcing the dollar lower against the currencies of our trading partners. That makes imports more expensive and compounds the effects of tariffs on costs.

5) Job losses outweigh job gains. Tariffs reduce competition, with the most protected industries not hiring enough to offset the blow to the hardest hit industries. This is especially true when there are so few domestic substitutes.

Few goods are 100% American made. That limits the industries that benefit from the protection of tariffs, while increasing those exposed to the downside.

6) Undermine productivity. Tariffs reduce competition, divert investment to less productive, protected industries and stifle large infrastructure investments. That undermines overall investment in and adoption of new technologies.

A recent study on the , when tariffs dominated our federal revenues, is particularly chilling. Some of the most “protected� firms exhibited a setback in productivity growth. Firms diverted funds to curry favor with politicians and lobby for their own interests.

Banks tighten their credit standards during periods of high uncertainty, especially for firms that may be exposed to tariffs. A widening of spreads between investment grade and junk bonds makes it harder for firms that need credit most.

7) Poor revenue generators. Tariffs have a more direct effect on demand than other taxes. They often fall short of estimates of what they can generate in terms of revenues.

The leverage of executive orders to implement tariffs further undermines their revenue-generating power, as they could be revoked at any point. That is why the nonpartisan Congressional Budget Office does not include tariffs issued via executive order in its scoring of the federal budget.

8) Erode export competitiveness. The blow to productivity, tighter credit standards and diversion of resources to protected sectors diminish our ability to export. Retaliatory tariffs, boycotts of US goods, curbs on foreign investment and travel to the US will further undermine exports.

9) Fail to level the playing field. Tariffs act as a stick instead of a carrot when lowering trade barriers. They often backfire as trade tensions escalate, which hurts our competitiveness at home and abroad.

Multilateral trade agreements work better at reducing hurdles to trade but require countries to adhere to rules and global enforcement mechanisms. The trust in global arbiters of trade conflicts eroded with China’s ascent to the global stage.

This year, the administration further weakened funding for rule-setting organizations and overrode the USMCA to penalize Mexico and Canada. That could have a lingering effect on our ability to negotiate trade pacts.

10) Stokes nationalism. Last, but by no means least, tariffs tend to stoke nationalism. The Smoot-Hawley Tariff Act of 1930 triggered a trade war between the US and 10 of the 25 countries affected by the tariffs. The tariffs covered more than 20,000 goods.

In response, global trade plunged 67%, which threw the global economy deeper into the depths of the Great Depression. Those losses helped sow the seeds of World War II.

The Marshall Plan and efforts to rebuild after that war were seen as key ingredients to a more lasting peace. The postwar dismantling of trade barriers was another component. The hope was that economic integration would diminish the incentives to go to war.

In more recent decades, that view shifted. There was a hope that countries that embraced trade would be more open to the tenets of democracy. That did not prove to be the case. China and Russia are two key examples.