U.S. Economic Shift: Impacts of New Policies on Growth and Inflation

Washington, D.C. – February 25, 2026 – U.S. Policymakers have initiated a systemic reorientation of the U.S. Economy, aiming to increase economic self-reliance and boost living standards for American workers. This shift encompasses efforts to expand domestic manufacturing, reduce the trade deficit and reliance on foreign goods, increase domestic energy output, limit reliance on unauthorized immigrant workers and decrease the federal government’s economic role. A recent International Monetary Fund (IMF) Article IV consultation focused on the macroeconomic effects of these 2025 policy changes, assessing their impact on the U.S., its trading partners, and the global economy.

A Buoyant Economy in 2025

The U.S. Economy demonstrated strong performance in 2025, aligning with IMF forecasts from January 2025, despite a different policy mix than initially anticipated. Growth reached 2.2 percent (year-over-year) driven by continued productivity gains, though a government shutdown impacted activity in the fourth quarter. Price inflation remained stable, with tariffs increasing goods prices while services inflation declined. Employment growth slowed, but labor markets remained near full employment, with an unemployment rate of 4.3 percent in January 2026. The inflow of foreign-born workers decreased, while labor force participation among prime-age workers rose. Financial conditions remained loose, with equity markets reaching record highs and corporate spreads narrowing. The federal fiscal deficit decreased from 6.3 percent of GDP in fiscal year 2024 to 5.9 percent in fiscal year 2025. The U.S. External position was moderately weaker than medium-term fundamentals suggest.

Implications of Recent Policy Changes

Fiscal Policy

Tax and spending changes enacted in 2025 are projected to modestly boost economic activity (approximately 0.75 percent of GDP in 2026-2027) and increase the deficit by around 1.5 percent of GDP. This boost stems from more favorable tax treatment of capital spending and lower household income taxes. However, from 2029 onward, as some tax provisions expire and spending cuts take effect, fiscal policy is expected to tighten, creating a drag on growth.

Tariffs

Higher tariffs are expected to modestly lower the trade deficit and generate approximately 0.75 percent of GDP in revenue in the near term. However, they represent a negative supply shock to the U.S. Economy, projected to raise the PCE price index by around 0.5 percent by early 2026 and reduce output by about 0.5 percent.

Immigration Policies

Stricter border enforcement and increased removals are anticipated to reduce the size of the foreign-born labor force, leading to slower employment growth, a modest increase in inflationary pressures, and a reduction in economic activity of around 0.4 percent by 2027.

Deregulation

The current administration is undertaking a comprehensive review of U.S. Regulations, requiring the elimination of ten existing regulations for every new one implemented. Efforts to boost the energy sector – by easing development of fossil fuels, geothermal, biofuels, nuclear, and hydroelectric assets and shifting incentives away from renewables – have been a particular focus. Actions are also underway to recalibrate financial regulations and establish a framework for digital assets. These measures are expected to support economic dynamism, though quantifying their macroeconomic effects remains challenging at this time.

The Outlook for 2026 and Beyond

Considering the effects of these policy changes, the IMF projects economic growth to accelerate to around 2.4 percent in 2026. The inflationary impact from tariffs is expected to diminish, allowing core PCE inflation to fall back to 2 percent by early 2027. Risks to near-term growth and inflation are considered balanced.

Employment growth is expected to be less than half the pace seen in the five years prior to the pandemic. However, given slowing population growth, the unemployment rate should remain near 4 percent in 2026-2027. The IMF has lowered its estimate of medium-term potential growth by 0.25 percentage points, with lower labor force growth offsetting gains in labor productivity.

The current account deficit is expected to decline modestly over the medium term to around 3.5 percent of GDP, but remain above pre-pandemic levels. The federal deficit is projected to exceed 6 percent of GDP in the next few years, and the federal debt-GDP ratio is expected to steadily increase over the medium term.

Risks to Activity

Potential upsides to the growth outlook include ongoing and proposed deregulatory efforts, which could loosen financial conditions, spur investment, and reduce energy costs. The surge in labor productivity over the past three years could also continue, particularly if technology adoption accelerates and infrastructure investments yield results.

Risks related to tariffs, taxes, and labor market dynamics are two-sided. The passthrough of tariffs to consumer prices could be lower than expected, leading to faster disinflation. However, uncertainty around trade policies could hinder activity, especially if supply chain reconfiguration proves difficult. The effects of tax changes and labor market dynamics also present both upside and downside risks.

Monetary and Fiscal Policy Recommendations

Monetary Policy

Given slowing job growth and limited signs of second-round effects from tariffs, the Federal Reserve’s removal of monetary policy restraint in 2025 was appropriate. The IMF views risks to the Fed’s dual mandate as balanced and sees limited scope for further policy rate reductions. The federal funds rate is projected to reach 3.25-3.5 percent by the end of 2026, supporting a return to full employment and 2 percent inflation by early 2027.

Fiscal Policy

Under current policies, the general government deficit is expected to remain in the 7-8 percent of GDP range, causing general government debt to reach 140 percent of GDP by 2031. While the risk of sovereign stress in the U.S. Is low, the rising debt-GDP ratio and increasing short-term debt represent a growing stability risk. A clear, frontloaded fiscal consolidation plan is needed to put debt-GDP on a downward trajectory, requiring a shift to a general government primary surplus of around 1 percent of GDP.