Expect tepid growth and, in the US, high inflation. More shocks could hit the global economy, writes The Economist
For years, the global economy has defied pessimists. When the coronavirus pandemic hit, many expected a long stagnation; instead, there was a rapid and inflationary recovery.
When central banks then raised interest rates to dampen prices, the widely predicted recession never happened.
And after President Donald Trump imposed “Liberation Day” tariffs on trading partners in April, markets plunged. Investors feared a giant trade war and a deep recession.
But tariffs were eased and stock markets began a surprising rally. Meanwhile, the real U.S. economy has been growing at a pace that, while significantly slower than before, is far from recession. Globally, growth has slowed, but not stopped.
Will this resilience continue in 2026? The threats to growth are almost innumerable. The lesson of recent years is that they are less likely to cause a collapse than some might fear.
However, they could still throw a lot of sand into the gears of the world economy.
For starters, Trump’s trade war is far from over. Right now, the average tariff rate on goods imported into the US, as measured by customs revenue, was just 10.5% (versus the threatened 28% estimated by analysts at the height of the April panic).
But the heaviest tariffs on China, the only country that has seriously retaliated against Trump, are simply on hold, despite recent conciliatory rhetoric from both sides.
And while the Supreme Court is likely to limit Trump's power to impose tariffs at will, his administration is preparing every legal option in its arsenal to keep tariffs high. A shift from one legal mechanism to another would create turmoil and uncertainty.
An immediate risk from the tariffs is their impact on the Federal Reserve's monetary policy. By the spring of 2026, the tariffs are likely to raise the core annual U.S. inflation rate by about one percentage point.
This could make the Federal Reserve (Fed) hesitant to cut interest rates as much as markets hope.
At least in 2022 and 2023, labor markets were booming as inflation rose. But as tariffs hurt, rather than boost, economic growth, the Fed may be forced to accept a looser-than-ideal labor market to keep prices in check.
The flip side of this risk is the possibility that Trump could change Fed policy to his liking in 2026, casting a shadow over the central bank's long-term credibility in the fight against inflation.
Jerome Powell, the Fed chairman, is expected to step down in May. His departure could open up a subsequent drama at the institution.
The most likely replacement is Chris Waller, a technocratic governor whom Trump appointed in his first term. If Trump chooses someone more partisan, Powell is expected to stay on as one of the Fed's governors, a special role for which his term does not end until 2028, in an effort to preserve the institution's independence.
Threats to central bank independence exacerbate another problem in the global economy: the dire state of government budgets. Deficit spending contributed to the world's resilience after the pandemic.
However, the crisis drove the public debt of advanced economies to higher levels than at any time since the aftermath of the Napoleonic wars.
France has changed five prime ministers in two years as it struggles to manage its budget; the British government is set to impose its highest taxes since the 1950s, yet is still short of funds; and even after accounting for tariff revenues, the US is likely to run a deficit of around 6% of GDP in 2026.
It's a surprising trajectory. And it carries with it the risk that governments will push central banks to keep rates low to ease the debt burden, a factor that Trump has used in his campaign against the Fed.
The growing risks of irresponsible fiscal policies and compromised monetary policies are increasing the likelihood of a crisis in bond markets, like the one Britain suffered in 2022.
A deep bond sell-off in a major economy like France or Japan could tighten global financial conditions; a U.S. bond market collapse would be a seismic event.
The last serious risk to the global economy is a decline in confidence in stock markets.
One explanation for this year's resilience is that growth has been supported by the boom in Artificial Intelligence (AI). As for the real US economy, this argument is often overstated, because the vast majority of AI chips, for example, are imported.
But the extraordinary strength of the stock market, fueled by confidence in AI, is likely making Americans feel richer, supporting their consumption. If this boom were to stop, the opposite would happen.
Without this development, there is no guarantee that there will be a recession. But, caught up in tariffs, debt and slowing growth, there would not be much left for it in the global economy./Monitor
