Forecasting 2025 under a second Trump administration raises big questions, economist Joel Naroff says

Economists love December. Instead of focusing on economic models, we start thinking about the future.

But forecasting the 2025 economy presents major challenges. We have a new president who appears ready and willing to impose his views of the economy on the country. Since no specific legislation has been proposed or passed by Congress, it is unclear what will actually be accomplished.

Consequently, the way to determine if 2025 will be better than 2024 is to focus on the key factors that should drive growth.

Trump has threatened raising tariffs so many times, it seems he has to do something.

So, let’s assume he raises tariffs on our major trading partners.

As tariff costs are normally passed through to businesses and consumers swiftly, the resulting impacts should become clear soon after they are implemented. The resulting price increases would be widespread, as a significant portion of the goods we buy come from foreign countries.

Worse, there will likely be significant collateral damage.

The Federal Reserve expects to continue lowering interest rates, but only if the inflation trend supports that posture. If inflation accelerates, the Fed is likely to slow rate cuts.

In essence, higher tariffs would not only create higher inflation, but higher interest rates as well.

The impact would be not just on short-term rates that the Fed controls, but on long-term rates as well. For example, mortgage rates would rise, reducing demand for buildings, factories, and homes.

Speaking of housing, Canada supplies much of the nation’s lumber, and higher costs would raise building expenses and home prices. The U.S. home construction industry would be taking hits from all sides.

As for Mexico, if you wonder why your Corona and guacamole cost so much more next Cinco de Mayo, look no further than tariffs.

Tariffs would slow growth next year for many reasons. The extent of the softening would depend upon the timing and the magnitude of the increases.

Just as tariffs raise prices, increase inflation, slow Fed rate cuts, and raise longer-term interest rates, a massive deportation of undocumented immigrants would likely to do the same.

A reduced labor supply not only raises wages and production costs, but also forces businesses to restrict output. The result: higher prices.

The biggest impacts will likely be felt in the agricultural and construction sectors, where undocumented immigrants represent about 13% or more of the labor force.

Undoubtedly, tax cuts will be a major priority of the new administration. Driven by the need to meet certain funding requirements, Republicans sunset a significant portion of the 2017 tax cuts, meaning those breaks would disappear. Republicans own the resulting tax increases, so expect them to vanish.

Normally, tax cuts are viewed as a big boost to consumer and business spending. But we have two years of experience to draw on, with Trump’s tax cuts in 2018 and 2019. The boost they created was limited.

The revival of sunsetting 2017 tax cuts, and any additional tax cuts, would likely boost 2025 growth modestly, but add significantly to the national debt.

Consumer spending remains robust, powered by strong wage growth. However, some of those income gains were due to boosts in the minimum wage in certain states and cities, which is now rising more slowly.

Still, the economy is at full employment, and solid growth will put pressure on wages. In sectors affected by deportations, labor shortages and wage increases could be significant.

In summary, rising household income coupled with tax cuts should ensure solid consumer spending.

Consumer confidence affects spending but where it is going is anyone’s guess. It is currently low but improving.

After Trump’s successful 2016 campaign, confidence surged. But anger about high prices played a major role in his 2024 victory and there is good reason to believe a return to higher inflation would negatively affect confidence and spending.

With all that in mind, the best guess is household spending should match its 2024 pace.

Similar to consumers, businesses face countervailing forces that raise questions about investment.

Companies invest when the opportunities are profitable. Higher borrowing costs make investing costlier. Uncertain consumer prospects limit expected sales. Together they reduce expected returns on investment.

That does not mean investment cannot accelerate.

The corporate sector is likely to benefit from tax changes. However, business investment gains were minimal in the two years after the 2017 tax cuts were passed, so saving the sunsetting 2017 benefits may not accomplish much.

In addition, whenever there are winners there are usually losers. Tax incentives for environmental and so-called green industries, such as electric vehicles, solar panels, and wind turbines, will likely be reduced or killed.

Also, there is the never-ending drive to repeal the Affordable Care Act, a.k.a. Obamacare. That would greatly reduce health-care spending and investment.

Commercial real estate is a different story. Many work-from-home employees are returning to offices. The high commercial vacancy rates spurred by COVID-19 shutdowns should reverse, benefiting cities and commercial real estate investors, as well as restaurants, retailers, and businesses that service the office sector.

Finally, there is the issue of reducing government regulations and increasing bureaucratic efficiency.

The so-called Department of Government Efficiency (DOGE) has massive plans. They include reducing or eliminating regulations and slashing government workforces.

DOGE leadership has openly stated that there will be pain in the short-term. Unfortunately, the extent and duration of that pain are unknown.

When you start cutting government, you disturb a political hornet’s nest. There is a saying that “one person’s pork is another person’s bacon” and when you attempt to shut things down, the affected voters and their elected officials who like their bacon fight really hard to keep it.

The outlook for the next year is filled with contradictory issues. Growth in 2025 will be determined by the speed and magnitude with which the Trump administration implements its promises. With a plan already in place there could be big changes early on.

Higher inflation, interest rates, and tariffs present risks to growth, but are somewhat balanced by the likelihood of solid income gains and tax cuts, so no major change in growth is expected. But given the next administration’s big plans, I wouldn’t bet the ranch on that forecast.