Economic policy

Faced with heightened uncertainty and the prospect of sizeable increases in the prices of many tradeable goods, central banks will need to remain vigilant to ensure that underlying inflation pressures are durably contained. A one-off rise in the relative price of tradeable goods due to tariffs is likely to be accommodated, but a sequence of such changes, or signs that inflation expectations are rising amidst still‑tight labour markets would likely require higher policy rates than would otherwise be the case. Set against this, any associated decline in output would place some general downward pressure on inflation. Such factors, and the potential for currency turbulence as policy rates diverge across countries, likely mean that policy decisions will remain finely balanced for some time to come.

Decisive fiscal actions are needed to ensure debt sustainability, preserve room for governments to react to future shocks and generate resources to help meet large current and impending spending pressures from ageing populations, climate change mitigation and adaptation measures, and plans to significantly enhance defence spending. Emerging-market economies also often have large investment needs in human and physical capital and still insufficient social safety nets. Debt-service costs are increasing in many countries as low‑yielding debt matures and is replaced by new issuance, with governments in some lower‑income countries now spending more on servicing debt than on education or health. Governments may also face calls for additional support in countries facing the adverse impact of higher trade costs. Well-designed and well-targeted government measures to support incomes can help if necessary to cushion the initial near-term impact of such shocks on companies and lower‑income households, but alternative, more structural, solutions are required where the adverse impact from shocks to external competitiveness is likely to be prolonged.

Governments need to find ways of addressing their concerns together within the global trading system to avoid a significant ratcheting up of retaliatory trade barriers between countries. As already highlighted, a broad‑based further increase in trade restrictions would have significant negative impacts on living standards. Efforts to avoid further trade fragmentation should be coupled with reforms that strengthen the resilience of supply chains, including by encouraging firms to diversify both suppliers and buyers. Diversification would be aided by common or shared regulatory standards on key intermediate production inputs between countries. Countries should also not lose sight of the opportunities for potential benefits from collectively agreeing to lower the current tariff and non-tariff barriers on goods and services. In an illustrative scenario in which all countries act to lower their average effective tariff rates by 1½ percentage points (relative to those assumed in the baseline projections), global output would be raised by close to 0.3% by the third year and global inflation reduced by close to ¼ percentage point on average in the first three years