OECD Economic Outlook, Volume 2025 Issue 1

1. General assessment of the macroeconomic situation

Introduction

The global outlook is becoming increasingly challenging. Substantial increases in barriers to trade, tighter financial conditions, weaker business and consumer confidence and heightened policy uncertainty will all have marked adverse effects on growth prospects if they persist. Higher trade costs, especially in countries raising tariffs, will also push up inflation, although their impact will be offset partially by weaker commodity prices. Global GDP growth is projected to slow from 3.3% in 2024 to 2.9% this year and in 2026 (Table 1.1), on the technical assumption that tariff rates as of mid-May are sustained despite ongoing legal challenges. The slowdown is concentrated in the United States, Canada and Mexico, with China and other economies expected to see smaller downward adjustments. Growth through 2025 is expected to be especially weak, with global output rising by just over 2½ per cent over the year to the fourth quarter, and by only 1.1% in the United States. Global trade growth is likely to slow substantially over the next two years, after significant front-loading ahead of expected tariff increases, and uncertainty is expected to hold back business investment. Fiscal easing will provide support in a handful of economies notably in China and Germany, where higher defence and infrastructure spending in 2026 could generate a significant upturn, but policy is likely to be mildly restrictive in many other countries. Annual headline inflation in the G20 economies is collectively expected to moderate from 6.2% to 3.6% in 2025 and 3.2% in 2026, but the United States is an important exception, with annual inflation expected to rise to just under 4% by the end of 2025 and remain above target in 2026.

There are substantial risks to these projections, with the scale and duration of the expected downturn remaining highly uncertain. Further increases or swift changes in trade barriers, including through retaliatory actions, as well as more cautious behaviour by consumers and firms, or continued risk repricing in financial markets could all intensify the growth slowdown and trigger significant disruptions in highly interlinked cross-border supply chains. Rising inflation expectations by households could prolong inflationary pressures, especially in economies facing substantially higher trade costs or with still‑tight labour markets, prompting more restrictive monetary policy and weakening growth prospects. Financial stability risks from still richly-valued and concentrated equity markets and high corporate financing needs could be triggered by additional risk repricing and amplified by forced asset sales by highly-leveraged non‑bank financial intermediaries. On the upside, a reversal of the increase in trade barriers would support growth and reduce inflation, even if it did not immediately result in lower policy uncertainty. Steps to ease regulatory burdens, and an early resolution to conflicts in Europe and the Middle East, could also improve confidence and incentives to invest.

Against this backdrop, the key policy priorities are to ensure a lasting decline in trade tensions, policy uncertainty and inflation, establish a credible fiscal path to debt sustainability while providing temporary support to those vulnerable to economic shocks, and implement ambitious reforms to strengthen growth prospects and improve competitiveness.

• Countries need to find ways of working together within the global trading system and to make trade policy more predictable. Agreements to ease trade tensions or potentially lower existing trade barriers would be welcome, improve policy certainty and strengthen the prospects for investment and growth. Steps to lower tariffs, deepen trade agreements or reduce barriers to trade in services would also benefit productivity and living standards. Key areas where opportunities exist for services trade reforms include further improvements in trade facilitation, reductions in regulatory barriers that impede access to national markets, and initiatives to enhance the cross-border digital delivery of services.

• Central banks should remain vigilant given heightened uncertainty and the potential for initial increases in trade costs to push up wage and price pressures more generally. The balance of risks for central banks will vary across countries, with the downside effects of higher uncertainty and weaker exports likely to be the key influences on policy decisions in most countries, but upside inflationary pressures being a more pertinent concern in countries raising tariffs. Provided inflation expectations remain well anchored, and trade tensions do not intensify further, policy rate reductions should continue in economies in which underlying inflation is projected to moderate or remain subdued.

• Faced with multiple spending pressures, governments need to ensure long-term debt sustainability and maintain the ability to react to future shocks. Stronger efforts to contain and reallocate spending and enhance revenues, set within credible medium-term country-specific adjustment paths, will be essential for debt burdens to remain manageable and to conserve the resources required to address longer term spending challenges. Higher debt service costs and some pressing spending needs, such as plans to raise defence spending substantially, are already forcing hard choices in some countries about the pace and composition of fiscal adjustment and limiting room for budgetary manoeuvre. In the near term, the automatic fiscal stabilisers should be allowed to operate fully to help cushion the adverse impact of trade tensions and elevated uncertainty. Targeted and well-designed support measures may also be needed to help companies but should be only temporary, as structural policy solutions are key if the adverse effects on external competitiveness are likely to endure.

• Rising protectionism, geopolitical uncertainty and weak growth prospects reinforce the need for ambitious structural policy reforms that strengthen living standards and promote economic competitiveness. A strong focus should be placed on policies to revive business investment, innovation and labour productivity, particularly ones that have a limited near-term fiscal cost. Elevated policy uncertainty, declining business dynamism and perceived difficulties in funding future investment in intangible assets are factors that need to be addressed in many OECD economies to strengthen investment growth.

Table ‎1.1. Global GDP growth is projected to slow

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Recent Developments

Global growth has been resilient but trade policy changes raise new challenges

After finishing 2024 on a sound footing, global GDP growth eased in the first quarter of 2025 (Figure 1.1, Panel A). However, economic developments were obscured by some front-loading of purchases ahead of the introduction of announced tariff rate increases. In the advanced economies, economic growth turned negative in the United States and Japan, but this was largely due to a surge in goods imports, with indicators of domestic demand growth holding up in both economies. Real GDP also contracted in the first quarter in Korea and several European economies, including Portugal, Norway, Slovenia, Denmark and Hungary. In contrast, output growth strengthened in Germany and the United Kingdom, partly reflecting stronger export growth, and remained solid in Spain and Ireland.

Most emerging-market economies generally continued to expand at a solid pace in the first quarter of 2025. In China, growth slowed a little but remained resilient, supported by expansionary fiscal and monetary policy and rapid export growth. There were also ongoing expansions in India, Indonesia and several Latin American economies, including Chile and Colombia. In Mexico, output growth picked up, helped by an improvement in agricultural output following weather-related disruptions in late 2024.

The impact of recent increases in bilateral tariff rates between the United States and its trading partners is likely to be increasingly evident in global economic indicators. These policy changes have coincided with a marked increase in newspaper-based measures of trade policy uncertainty (Figure 1.1, Panel B). As of mid-May, the United States had raised the tariff rate on most merchandise imports from China by 30% points, with China raising its tariff rate on merchandise imports from the United States by 10% points. Both countries had bilateral tariff rates of about 21% at the start of the year (Bown, 2025). The new rates are significantly below the peak bilateral tariff rates announced in April, which exceeded 100%, but it remains possible that those higher rates could be reinstated later this year. In addition, tariffs have been announced on those United States imports from Canada and Mexico not compliant with the United States‑Mexico‑Canada Agreement, with Canada taking targeted retaliatory action in response. The United States has also imposed a default tariff increase of 10 percentage points on all other trading partners, with the possibility that many countries could face substantially higher tariffs from July 2025. Certain products have been excluded from these increases, including United States imports of automobiles and automobile parts and steel and aluminium products, which face a separate tariff of 25%. Ongoing legal challenges bring additional uncertainty on some of these tariff measures.

Taken together, the new tariffs introduced by the United States this year up to mid-May are estimated to have raised the (ex-ante) effective tariff rate on US merchandise imports to 15.4%, from just over 2% in 2024, taking it to the highest rate since 1938 (Box 1.1).1 The US tariffs, together with retaliatory action by China, as well as more limited action by Canada, means that trade equivalent to over 2% of world GDP is now directly facing higher tariffs, pointing to much greater disruption than during the US-China trade tensions in 2018-19. If current applied tariffs are sustained, effective tariff rates are likely to fall over time, as trade in more heavily-tariffed goods is likely to slow.

Figure ‎1.1. Global growth was holding up ahead of recent trade policy announcements

Note: In Panel B, data are standardised from January 1960.

Source: OECD Economic Outlook 117 database; Data downloaded from https://www.matteoiacoviello.com/tpu.htm on 22 May 2025; and OECD calculations.

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Higher bilateral tariff rates are a drag on global activity and add to trade costs, raising the price of covered imported final goods for consumers and intermediate inputs for businesses, particularly in countries where tariffs are imposed. The initial effect on prices is likely to be felt close to the time of the tariffs being implemented, with the full impacts on output growth taking longer to materialise. Tariffs raise revenues for the government imposing them, but may also create distortions. The use of these additional revenues will condition the size and distribution of the economic impacts. At the same time, the expected slowing in economic growth in countries imposing tariffs will reduce other tax revenues. The impacts of recent trade policy changes may be more pronounced given heightened policy uncertainty, with elevated caution by businesses and consumers further weighing on investment and consumption growth.2 Taken together, higher tariffs and heightened uncertainty would be expected to weaken trade activity, although there is an upside risk in the very near term if exporters further bring forward trade to try and avoid the possibility of reciprocal or sectoral tariff rates being raised further in the next 2‑3 months.

Box ‎1.1. The impact of US tariff policy changes will be significant

This box outlines the main tariff changes implemented by the United States, the impact on the effective tariff rates across countries and the goods trade that might be affected. The Box reflects the tariffs applied as of mid-May, despite some uncertainty pertaining to ongoing legal challenges.

The extent of recent tariff changes from the United States and China is significantly larger than the previous episode of US-China trade tensions in 2018, with new tariff increases covering a broader range of goods. Even though bilateral goods trade between the United States and China has declined as a share of their total trade since 2018, it still represented around 2.5% of world goods trade in 2023 according to the OECD Balanced International Merchandise Trade dataset. Taking into account zero-rated items as well as tariffs on United States imports from other countries, trade equivalent to 2.2% of world GDP will be affected by the new tariffs (Figure 1.2, Panel A). In 2024, according to US data, China accounted for 6.9% of the United States’ merchandise exports, and 13.3% of US merchandise imports.

As a result of the combined trade policy changes introduced since January this year, the average effective tariff from the United States will rise to historically high levels, based on 2024 import patterns (Figure 1.2, Panel B). US imports of cars and car parts, and steel and aluminium products are now subject to an additional 25% tariff. In addition, tariffs have been raised on all countries by the United States, but with some sectoral and product exemptions. Collectively, the distribution of these tariff increases, as of mid‑May, differs widely by country (Figure 1.2, Panel C).

• Announced tariff increases have been highest for China, at 30%.

• Canada and Mexico also face higher tariffs, but a different tariff regime. They do not qualify for the exemptions granted to other countries, but rather face tariffs of either 25% or 0%, depending on whether their merchandise exports to the United States are compliant with the United States Mexico Canada trade agreement (USMCA). On average, around one‑half of their imports into the United States are thought to be USMCA-compliant at present, with compliance depending on the extent of local content and the filing of relevant rules-of-origin documentation. The high proportion of cars and parts in total exports to the United States raises the effective rates faced by Mexico, as well as a number of Asian and European countries, including Japan, Korea, Germany and the Slovak Republic. For Canada, the impact of the higher effective rate on cars and car parts is offset by the 10% tariff applied on its energy exports to the United States.

• In contrast, some products currently remain exempt from tariffs, including pharmaceuticals, semi‑conductors and other zero-rated items such as copper. This helps to lower considerably the effective US tariff on imports from countries such as Chile, Colombia, Ireland, Slovenia, and Switzerland.

The United States is an important export market for a number of countries, accounting for around 75% of goods exports for Mexico and Canada, 19% for Japan, 13% for China and 10% for Germany in 2023 (Figure 1.3). The importance of exports for overall activity also varies greatly by country. Exports to the United States are equivalent to over 20% of GDP in its North American trading partners, over 5% of GDP for many smaller open Asian economies and Korea, and between 3 and 4% of GDP for many European countries, including Germany and many of its key European supply chain partners. Exports from emerging-market economies such as China, India, South Africa and Türkiye represent a smaller share of their domestic output.

In value-added terms, the extent of direct exposure to the United States via exports is often smaller because of offsetting effects from intermediate inputs used in production for final exports. However, indirect exposures can also be significant due to integrated cross-border supply chains in Europe, Asia and the Americas. Data on the extent of such exposures is less timely, but highlight the comparatively high exposures of Mexico, Canada, Ireland, Korea and some other Latin American economies, such as Chile, Colombia and Costa Rica (Figure 1.4). Imports into the United States also include around 0.5% of US value‑added that was previously exported from the United States. Combined sector exposures are likely to be largest for the wholesale and retail sector, as well as cars and other manufacturing industries such as ICT, machinery and electrical equipment.

In addition to weaker trade volumes, domestic price increases are likely to follow higher tariffs, although the exact magnitude is subject to some uncertainty. Around 10% of the consumer basket in the United States is imported, directly and indirectly, before taking into account food and energy (Barbiero and Stein, 2025). It is likely that most of the impact of tariff increases will be borne by consumers and businesses, as occurred in the United States in 2018/19 when US tariffs on Chinese imports rose (Fajgelbaum and Khandelwal, 2022; Amiti et al., 2020 and Cavallo et al., 2021). The extent of price increases faced by consumers will depend on whether retailers just raise prices to cover the higher dollar cost or whether they maintain their current price-cost margin. For example, if retailers just passed-through the additional costs of a 60% tariff increase on China and a 10% tariff rise on the rest of the world, consumer prices could be expected to rise by 1.4 percentage points. By contrast, if retailers maintained a constant margin of selling prices over purchasing costs, consumer prices could rise 2.2 percentage points (Barbiero and Stein, 2025).

The eventual cost increases to consumers might further be mitigated by dollar appreciation, or if exporters or domestic producers lower their margins. However, experience from the 2018-2019 tariffs showed that even local producers who are not affected by imports may raise prices when most major competitors are being forced to raise costs, without fear of losing market share (Flaaen et al, 2020). There is also evidence that price increases tended to be rapid, often occurring within two to three months (Minton and Somale, 2025).

There are signs that a similar pattern may emerge this year. Minton and Somale (2025) estimate that US consumers already faced a 0.3 percentage point rise in core goods prices in March stemming from tariff increases on Chinese goods in February and March. Carvallo et al (2025) also find marked increases in US retailers’ prices of goods imported from China. Survey evidence suggests that US firms which rely on imported inputs tend to have markedly higher inflation expectations for 2025 than firms with low or no imported inputs (Edwards et al, 2025) and most importers expect to pass on cost increases over the next two years, in response to a range of tariff scenarios (Andrade et al., 2025).

In other countries, weaker economic activity in the United States may exert downward pressure on commodity prices and selling prices as exporters seek to aggressively expand into new markets. On the other hand, currency depreciation due to lower risk appetite and fears of further tariff action to protect industries may limit the extent of price discounting.

Figure ‎1.2. Recent trade policy announcements imply substantial change in effective tariffs

Note: Estimates based on trade policy announcements as of 14 May 2025. Panel A based on the USD value of affected imported US goods at the HS8 digit level, scaled by the share of nominal US goods imports as a share of nominal world GDP. Retaliation includes announced measures by Canada (USD 65bn) and China (all US exports), scaled by the share of nominal US goods imports as a share of nominal world GDP. Panel B based on the US International Trade Commission (USITC) estimate of the average effective tariffs until 2024. For 2025, the average tariff rate is calculated based on HS classifications of tariff-affected items matched to US Census Bureau data for 2024 import weights of product categories. Panel C excludes any estimate of the impact of the de minimis trade policy changes. The net sector-specific adjustment change includes a 25% tariff for listed cars and parts except for US-related content, provided that meets a minimum 20% (Canadian cars are assumed to have 25% US content, Mexico 20% and rest of world 0%, rounding results from the 2020 TiVA tables); a 25% tariff on steel and aluminium products; 0% tariff increases on any items listed in the official exclusions to the tariffs for all countries other than Canada and Mexico; and a 10% increase in tariff rates on all other goods for all countries, with the exception of Canada, Mexico and China. Mexico and Canada face a 25% tariff, except for energy and potash products from Canada which face a 10% tariff, and USMCA compliant goods which face a 0% tariff. Assuming 50% compliance, this equates to an effective tariff rate of 12.5% for all non-car goods. The United Kingdom is assumed to have a 10% tariff on cars based on the quota specified in the announced US-UK trade agreement, which accounted for 80% of the cars and parts exports, and 0% tariff on steel and aluminium. Data classifications are based on HS8 lists as published by the US administration. Weights are calculated based on 2024 US Census Bureau product level data for US imports, by country.

Source: OECD Balanced International Merchandise Trade (BIMTS); USITC; US Census Bureau; Canada Department of Finance; and OECD calculations.

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Figure ‎1.3. Direct exposure to US tariff increases

Direct exports to the United States in 2023

Note: Trade shares based on exports from the OECD Balanced International Merchandise Trade dataset for 2023.

Source: OECD Economic Outlook 117 database; OECD Balanced International Merchandise Trade (2023); and OECD calculations.

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Figure ‎1.4. Direct and indirect trade effects

Value added in global exports to the United States in 2023

Note: TiVA data is available until 2020. The value-added in USD for 2023 is estimated by applying each countries’ share of value-added in their gross exports to the United States in 2020 to the 2023 gross exports to the United States. The value-added is in non-service sectors ISIC4 A to C. Domestic GDP in current prices is converted to USD with market exchange rates.

Source: OECD Economic Outlook 117 database; OECD Trade in Value Added (TiVA) (Edition 2023); UN Comtrade; and OECD calculations.

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Some recent economic indicators have weakened though tariff increases may be bringing forward activity

Many survey-based economic indicators have recently weakened. Consumer confidence was already below long-run average levels in most economies but has shown further notable declines in Sweden, the United States, Lithuania and South Africa in the early months of 2025 (Figure 1.5, Panel A). In contrast, confidence has recently picked up in Türkiye, Poland and Chile. Empirical estimates suggest that the sharp fall in consumer confidence in the United States is mostly attributable to the increase in policy uncertainty since December 2024 (Figure 1.5, Panel B). The pace of retail sales has eased since last year in the United States and the euro area but has displayed greater resilience in China (Figure 1.5, Panel C). Business surveys suggest a slowdown in Canada, Mexico, Spain and the United States since the start of 2025 (Figure 1.5, Panel D), with available measures suggesting wide dispersion in firms’ expectations regarding the duration of tariffs. However, new orders for manufacturing goods remained strong in some euro area economies, including Germany and France, sustaining the pick‑up seen since the start of the year. Some of the ongoing strength in manufacturing activity in these economies likely reflects a temporary surge in demand for tradeable goods given the perceived risk of higher tariff rates from July 2025.

Figure ‎1.5. Recent economic indicators have weakened in several large economies

Note: In Panel A, the most recent data are for April 2025, except for Chile, Indonesia, Mexico and South Africa (March 2025), and Switzerland (February 2025). The latest information for Canada refers to the first quarter of 2025, and relates to 'Perceiving their financial situation is currently deteriorating'. The scenario in Panel B is based on the results from a cross-country model that regresses consumer confidence on developments in core, food and energy inflation, the unemployment rate, the share market index, house prices and the economic policy uncertainty index. The scenario assumes all else constant apart from economic policy uncertainty which remains at the level observed in December 2024. Panel D shows PMI manufacturing output for Mexico. The most recent data are for May 2025, except for Brazil, Canada, China, Ireland, Italy, Mexico, South Africa and Spain (April 2025).

Source: OECD Main Economic indicators database; Bank of Canada; S&P Global; and OECD calculations.

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Merchandise trade volumes rose strongly in late 2024 and the first quarter of 2025, helped by front-loading, with some exporters bringing forward planned shipments to the United States ahead of expected tariff increases (Figure 1.6, Panel A). The surge in US imports has been most apparent in industrial supplies, including steel and aluminium, in late 2024, and pharmaceutical goods in the first quarter of 2025, and has been accompanied by rising inventory growth for manufacturers and many retailers. International air freight traffic also rose in March and April, likely due to front-loading. More broadly, global container traffic continued to expand in the first quarter of 2025 and survey measures of manufacturing export orders have improved steadily in the advanced economies, with a normalisation in Germany (Figure 1.6, Panel B). Nonetheless, some signs are emerging that weaker performance is expected. Global container prices in April were 40% lower than at the start of the year. Routes between Shanghai and the United States have been heavily affected, both by the introduction of tariffs, which precipitated sharp declines, and the recent reduction in US-China tariff rates, which resulted in a 30% rebound in container shipping rates since the announcement – although rates remain 30% lower than at the end of 2024.

Figure ‎1.6. Near-term trade activity has been resilient

Note: Panel A refers to merchandise trade, average of exports and imports. Panel B includes May flash estimates for Germany and the United States.

Source: CPB Netherlands Bureau for Economic Policy Analysis; S&P Global; and OECD calculations.

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Financial market volatility has subsided but higher risk aversion persists

After pronounced turbulence in April, financial markets have normalised, with a strong rebound in global equity prices, declining equity and bond market volatility and a broad stabilisation of sovereign bond yields. Nonetheless, financial market conditions remain tighter than in late 2024 (Figure 1.7), as market volatility remains elevated and signs of risk aversion persist in some market segments, including for lower-rated corporate bonds and global companies exposed to the US market. In contrast to typical episodes of risk repricing, the US dollar has depreciated since the start of April, with investors significantly reducing their exposure to US financial assets.

Figure ‎1.7. Financial conditions are tighter than at the end of 2024

Note: The country financial condition indices, which are standardised around a long-term average, are obtained as the first principal component of a wide range of country-specific and global financial data series (15 country-specific indicators and 12 global indicators) including equities, interest rates, measures of volatility, sovereign and corporate bond spreads and exchange rates. Higher (lower) values of the FCI point to tighter (easier) financial conditions.

Source: OECD calculations.

Equity markets recovered in May, after experiencing a sharp decline across several advanced and emerging‑market economies following the US announcement of larger-than-expected tariffs on all trading partners in early April. Equity market performance in 2025 has been strongest in Europe and in selected emerging-market economies, particularly Brazil and Mexico. In Japan and the United States, equity valuations have essentially caught up to their levels at end-December 2024. Equity risk premia have recently declined after moderate increases in the United States, the United Kingdom and in Europe, while asset valuations continue to remain stretched.

There are persisting signs of some differences across companies according to their potential exposure to tariff barriers. Since mid-February, the equity prices of companies more highly exposed to the US market have underperformed others (Figure 1.8, Panel A). The magnitude of the decline has varied across regions, with the largest impact in China and Asia-Pacific economies. European companies have been affected to a lesser extent. As the announced tariffs have been relatively broad, the negative effects have weighed on equity prices in most sectors. The equity prices of US companies with significant international exposure also initially underperformed their more domestically focused counterparts in March and April, particularly in consumer goods and industrial sectors (Figure 1.8, Panel B), although this has subsequently moderated as the perceived risk of widespread retaliatory trade policy measures by other countries on imports from the United States has eased.

Figure ‎1.8. Equity prices of companies sensitive to US tariffs have underperformed

Note: Based on data up to 27 May 2025. Panel A displays two global non-financial corporate equity indices, excluding US companies. The first index reflects the stock performance of firms that are particularly sensitive to recent US policy changes, while the second represents the broader non-financial corporate equity market. Sensitive corporates are defined as ones with sales in the United States equal or exceeding 20% of their total sales. Panel B shows equity indices of internationally exposed and not internationally-exposed US non-financial corporates along with the broader non-financial corporate US equity benchmark. Internationally exposed US corporates are defined as those with international sales equal or exceeding 20% of their total sales. Corporates that are not internationally exposed have a ratio of international sales to total sales of 0%. The seven vertical dotted lines refer to five specific dates: 3 February 2025, the first trading day following the announcement of 25% US tariffs on all imports from Canada and Mexico and an additional 10% on imports on China; 11 February 2025, when a reinstatement of 25% US tariffs on all steel imports and a plan to increase tariffs on aluminium imports to 25% from March was announced; 27 February 2025, when an intention to implement a higher tariff on EU goods and introduce levies on other major trading partners was announced; 4 March 2025, when tariffs on Canada, Mexico, and China were partially implemented; 2 April 2025, when the US announced reciprocal tariffs that raised tariffs on most imports from all trading partners; 9 April 2025, when the US announced an increase of the US tariff rate on China to 145% and lowered reciprocal tariff rates on other partners for 90 days; and 12 May 2025, when the United States and China announced substantially lower tariffs, effective for an initial 90 days.

Source: OECD calculations.

Despite several episodes of volatility, long-term sovereign bond yields in most advanced economies currently stand at levels broadly similar to those recorded at the end of December 2024. After considerable fluctuations in April, yields have however increased in some advanced economies in recent weeks, notably in the United States where yields have been pushed up by a rising term premium amid concerns about policy uncertainty and public debt sustainability. In contrast, after a significant rise in March following the announcement of substantial additional expenditures on defence and infrastructure in Germany in the wake of the debt brake reform, long-term sovereign bond yields in the euro area have since declined, as investors have been seeking safe-haven assets. At the same time, policy rate cuts have continued in most advanced economies and some emerging-market economies, and markets continue to price in further rate reductions in most advanced economies.

Amid higher volatility in equity and currency markets, changes in sovereign bond yields in emerging-market economies have been relatively muted. Spreads on USD-denominated sovereign bonds have mostly reversed their increases in early April and are generally around their 2019 levels in major emerging-market economies. In Mexico, long‑term yields have steadily declined over the year, reflecting the weaker economic outlook. In Brazil, long-term yields have also recently declined, partly due to expectations of easing inflationary pressures, but are still around end-2024 levels and relatively high. In Colombia as well as South Africa and Türkiye, bond yields have risen in 2025 and are, on average, now higher than in the 2010s. In contrast, bond yields in many Asian emerging-market economies are around or below the average levels observed during the previous decade. Chinese long-term bond yields have weakened in April, with the expansion of fiscal support offset by the higher trade tensions and monetary policy easing, and are close to record lows. Long-term bond yields in India and smaller open economies such as Malaysia and Thailand have fallen since early 2025.

Corporate credit spreads over risk-free rates have narrowed from their peak levels in 2025, but remain elevated, particularly for lower-rated corporate bonds (Figure 1.9, Panel B). This signals growing market concerns over riskier assets, especially in the United States. Spreads on corporate bonds and leveraged loans had previously been at low levels, encouraging strong issuance but also raising risks of a sharp repricing if downside risks materialised. Leveraged loan issuance in the first quarter of 2025 was 40% higher than a year earlier. However, issuance of high-yield corporate bonds of the lowest ratings has been muted in the United States since early April. This freeze poses risks for private equity firms that often depend on the junk bond market for funding acquisitions, as well as for banks providing short-term loans for such transactions before firms secure longer-term financing. Bank lending and deposit rates have declined broadly in line with policy rate reductions, with signs of improvement in credit demand. However, credit standards for loans to firms tightened slightly in the euro area in the first quarter of 2025, reflecting a rise in perceived risks about the economic outlook.

Figure ‎1.9. Volatility has eased, but lower-rated corporate bond spreads remain elevated

Note: Based on data up to 27 May 2025. In Panel A, the implied volatility as measured by the VIX index can be interpreted as the market expectation of risk (future volatility). The MOVE index is a yield curve weighted index of the normalised implied volatility on 1-month Treasury options which are weighted on the 2-, 5-, 10- and 30-year contracts. Panel B shows option-adjusted spreads (OAS), which measure the difference in yield between a high-yield rated bond with an embedded option (such as a callable bond) and a sovereign bond. The difference between OAS of CCC and BB to B rated US corporate bonds is shown. It indicates the risk premium for investors in high-risk versus lower‑risk high-yield corporate bonds.

Source: Cboe Global markets; and OECD calculations.

Labour markets were easing but remained tight before new tariff measures

Employment conditions were already easing in many economies before the announcement of new trade policy measures, but labour markets generally remained in solid health. Median annualised employment growth in the final quarter of 2024 was 0.3% in the OECD, down from 0.8% in the first half of the year. Employment growth had also started to slow in some large non-OECD economies, including Brazil. Nonetheless, employment as a share of the working-age population was generally high compared with the pre-pandemic period, reflecting both relatively low unemployment and increased participation rates (Figure 1.10, Panel A). This was often enabled by older workers significantly increasing participation, such as in Czechia, Greece, Hungary, Italy, Poland, Portugal and Spain (Figure 1.10, Panel B). While the employment effects of the new tariffs and heightened policy uncertainty remain unclear, employment has fallen in recent months in some economies, including Canada and Japan. Employment conditions from business surveys have also eased notably, including in the United States, China, Canada, Mexico and India.

Figure ‎1.10. Older workers have been an important source of increased labour supply

Note: Latest value refers to 2025Q1 or 2024Q4 depending on availability.

Source: OECD Labour Market database; and OECD calculations.

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Nominal wage growth was moderating at the start of the year, but remained high in many regions compared to the pre-pandemic period. In most advanced economies, strong wage growth accompanied by limited productivity gains had kept unit labour cost growth above levels consistent with central bank inflation targets. Strong minimum wage increases were supporting ongoing wage momentum in some European economies, and robust base pay growth in Japan was accompanied by high winter bonus payments and a strong outcome in the annual wage negotiations for the 2025 financial year. Real wages were growing robustly at the end of 2024 and had returned to or surpassed pre-pandemic levels in most OECD countries following gradual disinflation. The imposition of new tariffs may result in stronger nominal wage demands as households respond to higher final goods prices. For example, around three quarters of respondents to the Canadian Survey of Consumer Expectations, undertaken in January and February 2025, expected their cost of living to increase because of the trade conflict.

Inflationary pressures have resurfaced in some economies

Inflationary pressures were still lingering in many economies early in 2025, with inflation often above target levels (Figure 1.11, Panel A). In the OECD, services price inflation remained elevated, largely due to stickiness in housing cost growth. At the same time, goods inflation had begun to rise, albeit from very low levels, primarily owing to stronger food price inflation (Figure 1.11, Panel B). The recent strengthening of food prices was most evident in Japan, the United States and the United Kingdom, as well as in some emerging-market economies like Costa Rica and Colombia. Overall, inflation developments in emerging-market economies have been more disparate. Despite having eased, annual headline inflation in Argentina and Türkiye was still tracking at double-digit rates, respectively, in early 2025. In contrast, inflation in China remained close to zero as of April.

Business surveys suggest manufacturing input and output prices have moved higher in advanced economies this year, particularly in Canada and the United States (Figure 1.11, Panels C and D). However, such measures do not suggest upward momentum in final services prices so far. Increased import tariffs are expected to induce an upward adjustment to price levels in the levying country. The persistence of the inflationary impact will depend on whether this is accompanied by higher nominal wage demands and increases in firm mark-ups. The magnitude of such second‑round effects is likely to be more modest in economies with well‑anchored inflation expectations.

Figure ‎1.11. Inflation remains high with goods inflation having recently picked up

Source: OECD Economic Outlook 117 database; OECD Consumer Prices database; S&P Global; and OECD calculations.

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Aggregate inflation expectations have moved higher in some economies. Financial market measures of 10-year breakeven inflation in major economies have not moved greatly, including in the United States (Figure 1.12, Panel A). However, short-run household inflation expectations have spiked in a few economies in recent months, most notably in the United States, but also in Canada and the United Kingdom (Figure 1.12, Panel B). This may partly reflect the recent inflation increase in items salient to household budgets, such as food, as well as the anticipated impact of higher tariffs on inflation. More granular data of both one‑year‑ahead and three‑year‑ahead inflation expectations highlight that the aggregate movements have reflected an increasing proportion of households expecting inflation to exceed 4% (see Box 1.2 below). Corporate inflation expectations have also increased in several advanced economies, including the United States, Canada, the United Kingdom and Japan (Figure 1.12, Panels C and D).

Figure ‎1.12. Inflation expectations have recently increased in some economies

Note: Based on data up to 27 May 2025. In Panel D, medium-term inflation expectations refer to 3-years ahead for Japan and the United Kingdom and 2-years ahead for Canada.

Source: Bank of Canada; Bank of Japan; Bank of England/Ipsos; Federal Reserve Bank of Atlanta; Banco de Mexico; European Central Bank; Bank of Korea; Office for National Statistics; University of Michigan; and OECD calculations.

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Projections

Global GDP growth is projected to slow from 3.3% in 2024, to 2.9% in 2025 and 2026 (Figure 1.13, Panel A; Table 1.1), with weakening economic prospects particularly evident in North America and some Asian economies, especially China (Figure 1.13, Panel B). On a Q4/Q4 basis, global growth is expected to slip to just 2.6% by the fourth quarter of 2025, from 3.4% in 2024, before recovering to 3% through 2026. These projections are based on a technical assumption that the bilateral tariff rates prevailing in mid‑May persist through the rest of 2025 and 2026, despite ongoing legal challenges.

Higher bilateral tariff rates and elevated policy uncertainty are expected to weigh on growth in business investment and trade. At the same time, consumer spending is also projected to soften in most economies as fragile sentiment and lingering cost of living pressures are compounded by the impact of higher trade costs on final goods prices and, in some countries, weaker labour market developments. The revised global growth projections are weaker than in the December 2024 OECD Economic Outlook and also the version of the March 2025 OECD Interim Economic Outlook projections that adopted the most comparable technical assumptions related to trade barriers (the “light tariff scenario”; Figure 1.13, Panel C). Inflation in G20 countries is expected to moderate gradually through 2026, with the inflationary impact from higher trade barriers offset by lower oil prices over 2025-26 and softer growth (Figure 1.13, Panel D; Annex 1.A). The United States is a key exception, with annual headline and core inflation now projected to peak at around 3.9% and 4.0% respectively in the fourth quarter of 2025 and remain above target in 2026.

Figure ‎1.13. Global growth is projected to weaken

Note: In Panel B, Emerging Asia comprises China, India, Indonesia and the Dynamic Asian Economies (Hong Kong (China), Malaysia, the Philippines, Singapore, Chinese Taipei, Thailand and Viet Nam). Latin America comprises Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru. Contributions calculated using moving PPP shares of global GDP.

Source: OECD Economic Outlook 117 database; OECD Economic Outlook 116 database; OECD Interim Economic Outlook 117 database; and OECD calculations.

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Central banks in many OECD economies are assumed to further lower monetary policy rates to mitigate the severity of the slowdown in economic growth and employment conditions. However, policy rates are expected to remain unchanged in 2025 in the United States given the upside risks to inflation. Another exception is Japan, where persisting inflation is anticipated to warrant continued gradual policy interest rate increases. Fiscal policy is assumed to tighten modestly in most of the large OECD economies over 2025-26, with the sustainability of public debt a common concern, but less so in many of the smaller economies. However, Germany’s reform of its fiscal rules and planned increase in defence and infrastructure spending are assumed to result in a sizeable stimulus in 2026, and much stronger public investment. In the United States, the assumed enactment of the One Big Beautiful Bill Act is also expected to result in some additional fiscal support in 2026. Most emerging-market economies are assumed to have a broadly neutral fiscal policy stance with some further monetary policy easing. China is an exception, with significant further fiscal expansion expected in 2025, with policy rates expected to be kept around currently low levels.

The prospects for individual major economies and regions are as follows:

• In the United States, output growth is expected to slow significantly due to the substantially higher effective tariff rate on imports, combined with retaliatory measures from some trading partners, elevated policy uncertainty and softer real income growth. In addition, a further slowdown in net immigration and reduction in the federal workforce are anticipated to moderate growth. On an annual basis, GDP growth is projected to weaken from 2.8% in 2024 to 1.6% in 2025 and 1.5% in 2026, with growth in the year to the fourth quarter of 2025 declining to just 1.1%. Similarly, new trade restrictions are anticipated to weigh on activity in Canada, with monetary policy assumed to provide only modest further support amid lingering inflation concerns. Canadian GDP growth is projected to fall from 1.5% in 2024 to 1.0% in 2025 and 1.1% in 2026. In both economies, a sizeable price level change is projected, with inflation anticipated to spike in mid-2025 before moderating towards target over time.

• The Japanese economy is expected to expand at a moderate pace, with private consumption growth supported by strong wage gains and business investment growth underpinned by healthy profits and government subsidies. Offsetting forces will be subdued external demand amid new trade restrictions and elevated trade policy uncertainty, with GDP growth projected to moderate from 0.7% in 2025 to 0.4% in 2026. In Korea, growth is projected to recover, with stronger real incomes and improving labour market conditions supporting household spending. After dipping from 2.1% in 2024 to 1.0% in 2025, GDP growth is projected to be 2.2% in 2026.

• Growth in the euro area is projected to remain modest at 1.0% in 2025, after 0.8% in 2024, before picking up to 1.2% in 2026, with increased trade frictions being offset by ongoing capital spending from NextGenerationEU funds, resilient labour markets and a recent easing of credit conditions. Additional cuts to monetary policy rates and the projected fiscal expansion in Germany are also expected to support growth, particularly next year. Modest increases in unemployment rates are expected to be accompanied by further moderation in wage growth. Price pressures are expected to abate further, with headline inflation in the euro area projected to be back around target in 2026. In the United Kingdom, growth is projected to be around estimated potential, at 1.3% in 2025 and 1.0% in 2026, as trade tensions and elevated uncertainty offset the positive impact from last autumn’s budgetary measures on government consumption and investment.

• In China, after robust growth at the start of 2025, the tightening of bilateral tariff rates and the planned elimination of the de minimis exemption on imports to the United States, combined with retaliatory trade measures, will weaken output growth. However, this is expected to be partly offset by domestic fiscal stimulus focused on government subsidies for consumer goods and social transfers. Real GDP growth is projected to ease from 5.0% in 2024 to 4.7% in 2025 and 4.3% in 2026, with increased trade costs and recent increases in global food prices pushing inflation up from its currently low levels.

• India and Indonesia are projected to continue to experience strong and broadly stable economic growth. While easing monetary policy will aid ongoing expansions in both economies, higher tariffs in the United States, global trade policy uncertainty, and domestic fiscal policy uncertainty in Indonesia, will have an offsetting effect. In India, economic growth is projected to be 6.3% in FY2025-26 and 6.4% in FY2026-27, while the Indonesian economy is expected to grow by 4.7% in 2025 and 4.8% in 2026. Inflation in both economies is projected to remain largely benign, although past currency depreciation in Indonesia will feed through into higher domestic prices and push up inflation this year.

• Growth in Mexico is projected to slow further in 2025 as higher trade barriers are combined with subdued increases in public spending. However, monetary policy easing will be a supportive factor, with output growth projected to be 0.4% in 2025 and 1.1% in 2026. In Brazil, growth is also expected to slow from 3.4% in 2024 to 2.1% in 2025 and 1.6% in 2026, as restrictive monetary policy and new trade barriers are only partially offset by the positive impact of expansionary fiscal policy. Inflation is projected to remain high but to fall back into the central bank target range in the second half of 2026.

The substantial changes to trade policies up to mid-May, with a technical assumption that they persist through the remainder of 2025 and 2026 are a significant drag to world trade in goods and services. Global trade is now projected to grow by 2.8% in 2025 and 2.2% in 2026, 0.8 and 1.3 percentage points lower respectively than the projections in the December 2024 OECD Economic Outlook. Much of the decline reflects lower trade in the United States, China, and regional partners who are heavily integrated into their global supply chains (Figure 1.14, Panel A). In 2025, the introduction of US import tariffs and greater trade policy uncertainty will also weigh on Europe, but a pick-up in domestic growth in Germany in 2026 should fuel a recovery in intra-EU trade. The front-loading of exports to the United States in late 2024 and early 2025, together with a continued expansion of services trade, limit the overall decline in annual trade volume growth in 2025. Nonetheless, quarterly trade growth is expected to remain weak for some time and global trade volumes in the fourth quarter of 2026 are 2.1% lower than previously projected (Figure 1.14, Panel B). Many emerging‑market economies, particularly commodity exporters, are expected to have much softer export growth as demand from both China and the United States is lower. However, some countries such as Argentina and Chile are relatively insulated, with half of their exports to the United States tariff exempt.

Figure ‎1.14. The regional drivers of trade growth are changing

Note: ‘Europe’ refers to OECD Europe. The Dynamic Asian economies are Hong Kong (China), Malaysia, the Philippines, Singapore, Chinese Taipei, Thailand and Viet Nam.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Despite the sizeable shifts in world trade volumes, changes in national current account balances are expected to be relatively limited (Figure 1.15, Panel A). Some key surplus countries such as China see a sharp slowdown in imports alongside exports, whilst in the United States weaker export growth limits the improvement in the overall current account that would have been generated by weaker import growth. One exception is Germany, where fiscal policy changes are expected to boost domestic demand and raise import growth even as export growth weakens due to trade policy changes; this results in a lower current account surplus. Overall, most countries’ current account balances are a smaller share of world GDP than prior to the global financial crisis, and remain largely unchanged over 2025 and 2026 (Figure 1.15, Panel B).

Figure ‎1.15. Current account balances will change only slowly

Note: Europe is OECD Europe. The Dynamic Asian economies are Hong Kong (China), Malaysia, the Philippines, Singapore, Chinese Taipei, Thailand and Viet Nam. The world current account balance does not necessarily equal zero because each country compiles its own national accounts with differences in definitions and sources.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Employment growth in the OECD is expected to weaken, with the annual pace of employment gains in the median OECD country projected to be 0.7% over 2025-26, down from 1% in 2024 (Figure 1.16, Panel A). Employment growth is projected to be more resilient in some non-OECD emerging economies, such as India and South Africa, but to continue to slow in China as the ageing population further reduces labour supply. Labour force growth is also generally projected to ease from its recent fast pace, with migration inflows moderating in some economies. Consequently, the median unemployment rate across OECD economies is projected to remain broadly stable over the projection horizon. However, higher unemployment is projected in the United States as growth slows, with the unemployment rate rising towards 4½ per cent in the first half of 2026 before starting to moderate.

With demand and supply in labour markets in better balance, nominal wage growth is projected to continue to ease in most economies (Figure 1.16, Panel B). This will combine with a projected improvement in labour productivity growth to facilitate further easing in unit labour cost growth and, in turn, reduce inflationary pressures. Further declines in headline inflation are projected in most advanced and emerging‑market economies where inflation is currently exceeding the central bank target (Figure 1.17). In addition to the United States, exceptions include South Africa, where inflation will be pushed up by an increase in value added tax and the narrowing output gap, and Brazil, where a recent upturn in services inflation will keep annual inflation high despite a projected fall in quarterly inflation throughout 2026. In the euro area, inflation will remain relatively elevated in a number of economies with tight labour markets, including Latvia, Lithuania, the Slovak Republic and Slovenia.

Figure ‎1.16. A more balanced labour market and stronger productivity growth should support disinflation

Note: In Panel B, median nominal wage growth does not include Chile, Colombia, Costa Rica and Türkiye due to a lack of available comparable data.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Figure ‎1.17. Inflation is projected to move further towards targets

Headline consumer price inflation

Note: Argentina and Türkiye are shown on the right-hand scale, all other countries on the left-hand scale. Personal consumption expenditure price index for the United States, harmonised index of consumer prices for the euro area aggregate, euro area member states and the United Kingdom, and national consumer price indices for all other countries. India projections are based on fiscal years, starting in April. OECD is computed as the median of member countries.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Risks

Growth could be hit by more restrictive trade policies, prolonged uncertainty and tighter financial conditions

A key risk is that bilateral tariff rates are raised further on merchandise imports into the United States, potentially prompting retaliatory measures by trade partners. Such developments would be likely to intensify risk repricing in financial markets and prolong policy uncertainty. This would also sap confidence, add to the downward pressures on corporate and household spending around the world, and weaken global demand for many key commodities.

A set of illustrative simulations using the NiGEM global macroeconomic model in forward‑looking mode highlights the different near-term effects that some of these developments might have (Figure 1.18):

• A scenario in which US bilateral tariff rates are raised further by an additional 10 percentage points on all countries could lower global output by just under 0.3% by the second year, with a larger fall of 0.6% in the United States. Inflation would also be higher, rising by an average 0.8 percentage points per annum in the United States in the first two years and by close to 0.5 percentage points per annum in the world. While the strongest effects are felt in the United States, weaker US import demand reduces export growth in all trading partners, and an appreciation in the dollar effective exchange rate of close to 4% mitigates the inflationary impact in the United States but raises import prices elsewhere.

• The initial shock to growth would be amplified if accompanied by a further deterioration in global equity markets and heightened risk premia due to greater uncertainty, and greater precautionary saving by consumers. In the illustrative scenario, equity prices are assumed to fall by 10%, investment risk premia increase by 50 basis points and household saving rates to rise by 1 percentage point, with these shocks lasting for two years. Collectively, the combined shocks could push global output down by around 1.2% by the second year, with larger declines in many advanced economies. The additional demand shocks are deflationary, reducing both consumer spending and investment, and so the impact of higher trade costs on inflation would be reduced, with the increase in global inflation slowing to an average 0.2 percentage points per annum over the first two years.

• Commodity prices are likely to be an additional shock absorber, with weaker global demand likely to push down prices, at least in the near term. This would help to support real incomes in commodity-importing economies and lower headline consumer price inflation. An illustrative decline of 10% in global oil and gas prices could reduce global inflation by an average 0.3 percentage points per annum in the first two years, with the largest declines in more energy-intensive non-OECD economies, and raise global output by around 0.1%. Combined with the other illustrative shocks, global inflation would be little changed overall, with global output falling by 1.1% by the second year of the shock.

• The balance of these different shocks if they were to occur would have implications for macroeconomic policies. In the illustrative initial trade policy shock, policy interest rates are raised in the United States to help mitigate potential second-round effects on inflation, with rates rising relative to baseline by around ¾ percentage points on average in the first two years. The appreciation of the dollar exchange rate helps to raise import prices in other countries, with policy interest rates rising modestly in most in response. In the full combined shock, policy interest rates decline in all economies, reflecting the overall deflationary nature of these shocks. Fiscal pressures would increase as a result of the combined shocks, with weaker activity initially reducing tax revenue and higher unemployment adding to spending costs. After two years, government debt‑to GDP ratios are raised by around 2 percentage points in the typical advanced economy.

The impact of additional policy uncertainty could be even higher than shown in the illustrative scenario. Empirical estimates suggest that a one standard deviation shock to the economic policy uncertainty index is associated with a 1% cumulative decline in investment (see further discussion in Chapter 2). To put this in context, the economic policy uncertainty index for Canada rose by over 9 standard deviations between October 2024 and March 2025.

Figure ‎1.18. Further trade cost increases and heightened uncertainty would harm growth

Note: Simulated impact of an unanticipated increase of 10 percentage points in US tariffs on all non-commodity imports, a decline of 10% in equity prices in all countries, a rise of 50 basis points in global investment risk premia, a rise of 1 percentage point in household saving rates in all countries and a 10% decline in oil and natural gas prices. The tariff increases persist but the other shocks are assumed to fade gradually after two years.

Source: OECD calculations using the NiGEM macroeconomic model.

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Inflation could be more persistent

An additional downside risk is that inflation remains stickier than otherwise anticipated. This could prompt more restrictive monetary policy, weakening growth prospects. Inflation remains above central bank targets in most OECD economies. In addition, the higher tariff rates imposed by the United States and China may result in higher-than-expected upward price adjustments for final goods in these economies, and higher costs that feed through to export prices. Any future effective exchange rate depreciation in other countries would also further raise import prices in these jurisdictions. As discussed above, another key risk is that tariff-induced price increases are accompanied by significant second round effects that cause further inflation persistence. Workers’ responding to lower purchasing power by pushing for higher nominal wages could raise costs for firms that may be passed onto consumers in the form of higher prices. Attempts by companies to maintain their existing price-cost margins would also amplify the impact of the initial rise in import costs. Tight labour markets in many economies, combined with signs of rising consumer (Box 1.2) and corporate inflation expectations in some economies (Figure 1.12, Panel C), are factors that may elevate the probability of this risk occurring. Labour‑intensive services sectors could experience particularly high inflation under such a scenario.

Box ‎1.2. The distribution of household inflation expectations

The distribution of inflation expectations provides information about the degree to which expectations are anchored to central bank inflation targets and how risks to inflation expectations are evolving through time. Recent moves upward in one-year ahead aggregate inflation expectations in the United States and Canada have been accompanied by a material increase in the proportion of respondents expecting inflation to exceed 4% in these economies. Around 48% of respondents in the United States in April 2025 expected inflation to be above that level, up from 35% in November 2024 (Figure 1.19, Panel A). In Canada, the proportion of respondents expecting inflation above 4% one-year ahead rose to 57% in the first quarter of 2025 from 44% in the fourth quarter of 2024 (Figure 1.19, Panel C). While there has also been an upward shift in the distribution of inflation expectations in some European economies, including Spain and the United Kingdom, this has not been the case in others, such as France, Italy, Germany and Belgium (Figure 1.19, Panel E and F).

Figure ‎1.19. An increasing share of households in the United States and Canada are now expecting high inflation

Note: In Panels E and F, “Latest” is March 2025 for all countries other than the United Kingdom (February 2025). In Panel F, data are for inflation expectations two‑years ahead for the United Kingdom.

Source: Bank of Canada; Bank of England/Ipsos; European Central Bank; Federal Reserve Bank of New York; and OECD calculations.

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In comparison to the period immediately prior to the pandemic, the proportion of respondents in the United States and Canada expecting inflation to be at the inflation target has declined. This is also apparent when assessing the shifts in the distribution of expectations for inflation in the medium term (three-years ahead for the United States and two-years ahead for Canada; Figure 1.19, Panel B and D). There has also been a slight decline between late 2024 and early 2025 in the share of respondents expecting inflation to be at target.

Corporate financial strains may prompt further risk repricing and spillovers across financial institutions

Risk repricing in financial markets could be even more extensive in the event of downside surprises to economic growth or a resurgence of inflation. This would heighten market volatility and increase risks to financial stability. Despite recent moderation, asset valuations remain elevated in the United States and a few other markets (Figure 1.20, Panel A), and equity benchmarks remain highly concentrated (Figure 1.20, Panel B). Across both advanced and emerging economies, earnings expectations have continued to grow (Figure 1.21, Panel A), although some signs have begun to appear recently that suggest expected earnings may have plateaued in the United States. Potential risks to corporate earnings include a greater‑than-expected impact of higher trade costs on profitability, as well as a more extensive economic slowdown than projected (Figure 1.21, Panel B). If there is a downward adjustment to earnings expectations, there could be sizeable further equity market corrections.

Figure ‎1.20. Equity prices remain richly valued and many financial markets are increasingly concentrated

Note: Panel A shows price-to-earnings ratios in selected G20 economies. Based on data up to 27 May 2025. The current price-to-earnings ratio (PER) is calculated by dividing the share price by the trailing 12-month earnings per share (June 2024 to May 2025) for companies listed in the benchmark. The cyclically adjusted price-to-earnings ratio (CAPE) is calculated using 10-year average “cyclically-adjusted” earnings, expressed in April 2025 prices. A higher CAPE ratio compared to the PER indicates that stocks are richly valued. The concentration of equity benchmarks in Panel B is the share of the top 20 companies in the total market capitalisation of each equity benchmark for advanced and emerging-market economies. The concentration in corporate bond markets is based on the share of total issuance by the 100 top bond issuers each year. These are identified using the amount of long-term debt reported on their balance sheets.

Source: Bloomberg; OECD Capital Market Series dataset; and OECD calculations.

Figure ‎1.21. Expected corporate earnings continue to rise despite the widespread equity market decline in early April

Note: Panel A shows the 12-month forward earnings per share for non-financial corporates listed in selected equity benchmarks (weighted average by market capitalisation). Panel B presents the sectoral distribution of companies that experienced a decline of 10% or more in their equity prices between 31 March and 7 April 2025 (i.e., 286 in the United States, 265 in other advanced economies, and 124 in EMEs). These companies have been selected among the top 500 companies listed in selected equity benchmarks. For example, in the United States 28% of the companies with a correction were technology firms.

Source: OECD calculations.

Elevated levels of marketable and non-marketable corporate debt,3 with a large and growing share of non-investment-grade bonds and leveraged loans,4 and high corporate refinancing needs in the near future pose risks to financial stability (OECD, 2024a; OECD, 2025a). The expected default risk premium for low-rated corporates has risen markedly in North America, Europe, and Asia since mid-February, and despite recent moderation remains above levels observed prior to the announcement of higher tariffs in the United States. (Figure 1.22, Panel A). Concerns that banks could face higher non-performing loans were reflected in the decline in their price-to-book value ratios in April 2025 (Figure 1.22, Panel B) and higher expected default risk premia at large banks around the world. Weaker corporate financial conditions, combined with high uncertainty induced by additional tariffs in the world trading system, could also raise financing costs and deter fixed investment.5

Figure ‎1.22. Default risk premia have risen and bank performance has weakened

Note: Based on data up to 27 May 2025. Panel A presents selected corporate credit default swap (CDS) indices, which serve as indicators of default risk premia. The North American index comprises the 100 most liquid entities with high-yield credit ratings traded in the CDS market. The European and Japanese indices consist of the 125 and 40 most liquid investment-grade entities, respectively, traded in the CDS market. The Bank CDS Index (weighted by market capitalisation) is constructed using the credit default swaps of the 34 most liquid large-cap banks globally. Panel B shows the price-to-book (P/B) ratios of banks included in bank equity benchmarks across selected economies. The P/B ratio compares a bank’s current market capitalisation (i.e. its equity market value) to its accounting book value. A P/B ratio below 1.0 suggests that the market may be undervaluing the bank or that the bank may be slow in marking down impaired assets.

Source: Bloomberg; and OECD calculations.

A change in investors’ risk appetite could trigger widespread sell-offs of corporate bonds, especially by non-bank financial institutions. Given the low liquidity of high-yield corporate debt, even limited shocks can generate large price corrections, with significant risks of fire sales. Over half of investment-grade corporate bonds are just above the threshold for high-yield status.6 If these bonds are downgraded, institutional investors bound by rating-based regulatory requirements will be obliged to sell them. Sales pressures during a downturn could also be exacerbated by pro-cyclical behaviour, especially given relatively high investor concentration in major corporate bond markets (Li and Yu, 2022; Boermans and Veumeulen, 2016), and by redemptions at investment funds. Real estate investment funds are particularly vulnerable to these effects, given the illiquid nature of their assets and the persistently uncertain outlook for the commercial real estate market. Real estate investment trusts experienced a marked decline in performance in April, with the industrial and retail sectors being hit hardest.

The high price volatility of crypto-assets and the growing interconnectedness between non-bank financial intermediaries, banks and the crypto-asset market raise substantial risks to financial stability. The market capitalisation of crypto-assets has grown rapidly in recent years, reaching a historical peak of USD 3.7 trillion in mid-December 2024, up from USD 200 billion in January 2020. Subsequent sharp price falls until early April, partly reversed afterwards, suggest elevated valuations and a high sensitivity to repricing in other asset classes (IMF, 2025). The largest single component of the crypto-asset market is Bitcoin, which now represents over two-thirds of market capitalisation, supported by high inflows into Bitcoin exchange-traded products. Crypto-assets often remain less regulated than traditional financial instruments, and data gaps hinder financial stability assessment (Aerts et al. 2025). A particular concern is that price corrections in crypto-assets and potential losses of retail and institutional investors and leveraged investment funds could spill over into other parts of the financial sector and the wider economy amidst forced deleveraging in response to market losses (OECD, 2022a). For instance, redemptions of stablecoins, often reserve‑backed by short-term debt instruments, could under certain conditions trigger liquidity runs and pose significant disruption to short-term debt markets (OECD, 2022b).

Market concentration and leverage may amplify shocks

Higher volatility in equity prices amid concentrated markets remains a concern as there is a greater risk of idiosyncratic shocks spilling over and becoming systemic. The market value of equity and bond markets is often concentrated in a handful of individual stocks or bond issuers, raising the risk of large idiosyncratic sectoral or firm shocks spilling over and becoming systemic.7 A sudden price decline or rise in bond yields could also be amplified by forced asset sales by leveraged and illiquid investment funds, particularly since a small number of funds account for a large share of total corporate bond investment fund assets (OECD, 2025a).8

The growth of passive investment funds (which track the returns of established market benchmarks) may contribute to increased market concentration and stronger co-movements in stock prices, potentially amplifying the impact of negative shocks. Continued inflows into passive funds often disproportionately increase the market capitalisation of the largest companies in equity benchmarks, further concentrating equity markets and heightening their vulnerability to idiosyncratic risks (ECB, 2024). Passive investment funds managed about USD 15 trillion (51.6% of total fund assets) in 2024, up from USD 2 trillion (19.7%) in 2012 (Figure 1.23, Panel A).9

The rise in passive investing has also made the demand for individual stocks more inelastic, potentially leading to higher price volatility and lower liquidity (Haddad et al., 2021). As passive asset managers buy (sell) the whole basket of index constituents in response to fund inflows (outflows) and only adjust their portfolios in line with changes to the index composition, trading commonalities may increase among stocks, with stronger price co-movement. Greater price co-movement amid concentrated markets could threaten systemic stability by increasing the likelihood that many investors face losses simultaneously following firm or sector-specific shocks, triggering waves of redemptions from investment funds and synchronised sell-offs (ESRB, 2019; Chinco and Sammon, 2024; ECB, 2024; OECD, 2025a).

Figure ‎1.23. Global passive investing and use of derivatives by non-bank financial intermediaries have risen

Note: Panel A displays total assets under management of investment funds (i.e. mutual and exchange traded funds) globally according to their active or passive investment strategies. Passive portfolio management is a strategy that tracks the returns of a market benchmark. By contrast, active investing aims to outperform a targeted benchmark through discretionary securities selection or trading in anticipation of market turning points. Panel B shows two proxies of leverage through the use of derivatives for non-bank financial intermediaries: the aggregate notional value of over-the-counter) derivative exposures and the ratio of notional amounts to gross market value of over‑the‑counter derivative exposures (FSB, 2023).

Source: Bloomberg; Bank for International Settlements; Financial Stability Board; and OECD calculations.

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The leveraged investment strategies and use of derivatives by some non-bank financial intermediaries could also amplify volatility (Figure 1.23, Panel B). The use of derivatives, particularly by speculative investment funds such as hedge funds, might enhance interconnectedness through complex intermediation chains. An unexpected rise in yields (or equity declines) can lead to rapid unwinding of leveraged trades, with forced selling in an illiquid market prompting further market weakness and margin calls (IOSCO, 2024; FSB, 2024). In early April 2025, following tariff announcements, hedge funds recorded the steepest margin calls since the onset of the pandemic.10 Interconnections between banks and non-bank financial intermediaries could also lead to spillovers to the financial institutions that provide funding to investment funds when the latter face large outflows (OECD, 2024c; BIS, 2025).

Financial market volatility also raises risks in emerging-market economies

The risk of disruptive capital flows has risen in emerging-market economies. Between October 2024 and January 2025, capital flowed out of emerging-market economies (Figure 1.24, Panel A), partly driven by the relative strength of the US economy. However, this reversed in February and March as fears of a slowdown in the United States rose and the spread between emerging-market and US bond yields widened (Figure 1.24, Panel B). In most emerging‑market economies, bilateral US dollar exchange rates have appreciated in 2025, especially since April, with a strong rise in the Brazilian real, the Mexican peso and the Taiwanese dollar, as investors reduced their exposure to US assets. Capital flows are likely to remain volatile as risks of sharp asset repricing and high uncertainty persist. For some emerging market economies, large and sudden capital inflows can lead to strong appreciation and may prove challenging to manage. However, many emerging market economies are at risk of experiencing capital outflows if relative economic prospects and global risk sentiment deteriorate, which could lead to depreciation pressures and higher financing costs.

Many emerging-market economies remain vulnerable to debt distress. Sovereign debt levels and borrowing costs have risen significantly in recent years. Government debt as a share of GDP is now higher than in 2019 in almost three quarters of emerging and developing economies (World Bank, 2025). In these circumstances, borrowing is likely to become more challenging. Around 40% of total outstanding high‑risk government bonds at the end of 2024 will mature in 2025 and 2026 (Figure 1.25, Panel A), and approximately 20% of all bonds have been issued before 2021, when interest rates were lower (OECD, 2025a). Larger countries and those with a higher credit rating have more developed local bond markets and broader access to finance. In contrast, lower income and high‑risk countries rely more on foreign currency borrowing and are susceptible to changes in exchange rates and in risk sentiment. Although low‑income countries have less direct exposure to trade with the United States than middle-income countries (Figure 1.25, Panel B), half remain at high risk of distress or are in distress, as many advanced countries have recently reduced foreign aid.

Figure ‎1.24. Capital flows have been sensitive to exchange rate movements relative to the US dollar

Note: Panel A shows the gross portfolio inflows data from the OECD Monthly Capital Flow dataset for 23 emerging-market economies grouped by four geographical areas. Panel B shows mean 10-year USD bond yields and the median level of the nominal USD exchange rate across seven major emerging-market economies (Brazil, China, India, Indonesia, Mexico, South Africa and Türkiye). Based on data up to 27 May 2025.

Source: OECD Monthly Capital Flow dataset; and OECD calculations.

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Figure ‎1.25. Borrowing has become more challenging for lower income and riskier countries

Note: The data in Panel A cover a sample of nearly 8 700 bonds from 95 countries. The maturity composition is a weighted average based on the outstanding amounts of the corresponding debt within each credit rating category. Category ‘A’ includes all bonds rated A and above while the ‘high-risk’ category refers to all bonds rated below BB. The categories are based on aggregated credit ratings from different ratings agencies; see Annex 3.A in OECD (2025a) for the detailed methodology. Panel B shows exports of goods to the US as a share of all exports of goods and services and as a share of GDP. Income classifications are based on World Bank definitions, and the panel shows simple averages across countries in each income group.

Source: OECD (2025a); WTO; World Bank; and OECD calculations.

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There are several possible sources of positive surprises

There are also various upside risks to the forecasts that would push economic growth higher if they were to occur. The baseline scenario assumes that the recent increases in bilateral tariff rates remain in place throughout 2025 and 2026 in all countries. A reversal of these restrictions, or steps towards a broader agreement to lower tariff barriers from current levels, would boost growth and reduce inflation relative to the baseline (see Figure 1.36 below).

Additional structural reforms that lower the economic costs of regulation could also promote stronger growth. In the United States, initiatives are underway to lighten the regulatory burden by eliminating measures that create significant costs for businesses and households without effectively addressing market failures. Agency heads are currently reviewing all regulations under their jurisdiction to identify those that should be rescinded (The White House, 2025). Faced with higher trade barriers, other countries may also be prompted to undertake growth-enhancing structural reforms that promote international competitiveness. New OECD analysis highlights that regulatory reforms in network sectors could produce significant economy-wide gains: if network sector regulations in more regulated countries converged to those in the least-regulated countries, economy-wide labour productivity could rise by 1.7% (Andrews et al., 2025). Similarly, further efforts to harmonise regulations across countries, including within the European Union, or between subnational jurisdictions, such as in Canada or Australia, could support stronger trade and productivity growth.

A peaceful resolution of conflicts in Europe and the Middle East could also reduce geopolitical uncertainty and improve confidence, providing a tailwind for spending and investment. Additional public defence spending could also have positive implications for growth, though this is not necessarily the case if financed by cutting other forms of government spending. There may also be an upside risk from the prospect of further declines in oil prices. Global oil supply is expected to outpace demand in the near term, owing both to weaker global demand growth and strong anticipated increases in oil production in several non-OPEC countries including the United States and Canada (IEA, 2025).

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Tariff increases complicate monetary policy decisions

Policy interest rates have declined further in most advanced economies in recent months, with the notable exception of Japan, where policy accommodation continues to be gradually withdrawn. Central bank balance sheet reductions have also continued, though the United States has slowed down quantitative tightening and Canada has announced plans to bring it to an end. The monetary policy stance remains restrictive in most countries, with forward‑looking long-term real interest rates well above pre‑pandemic norms and having edged up slightly in recent months, especially in Europe (Figure 1.26, Panel B). In contrast, short-term real rates have fallen, particularly in the United States (Figure 1.26, Panel A) due to an increase in one‑year ahead inflation expectations.

Figure ‎1.26. Long-term real interest rates remain high but short-term real rates have declined

Note: Based on data up to 27 May 2025. In Panel A, the real short-term interest rates are calculated using nominal one-year government bond yields and one year-ahead inflation expectations by consumers in the United States, the euro area and the United Kingdom, and by corporates participating in the Tankan Survey in Japan. In Panel B, the real long-term interest rates show 10-year inflation-linked bond yields.

Source: Bank of England; Board of Governors of the Federal Reserve System; Bank of Japan; European Central Bank; University of Michigan; and OECD calculations.

Faced with heightened uncertainty and the likelihood that tariff increases will raise goods price inflation, 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 is likely to be accommodated. However, a sequence of such changes, or signs that inflation expectations are rising and rekindling wage pressures in 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. The balance of these pressures may differ across countries. The downside effects of higher uncertainty and weaker exports are likely to be the main factors in many countries exporting to the United States, but countries raising tariffs will face pressures from sizeable price increases as well as those from softer growth.

Provided trade tensions do not intensify further and inflation expectations remain anchored, policy rate reductions can continue in economies where inflation is projected to moderate. Further moderation in nominal wage growth and continued progress in disinflation in services sectors will be critical factors that enable monetary policy easing to proceed smoothly. Under the projected outlook for inflation and GDP growth, policy rate reductions are expected to continue during 2025 and in some cases 2026 in all the major advanced economies other than Japan (Figure 1.27).

• In the United States, the federal funds rate is projected to remain unchanged through 2025, with rates then being lowered to 3¼-3½% by the end of 2026. Bond holdings are projected to decline further throughout 2025-26, albeit at a slower pace reflecting the lower monthly redemption cap for Treasury securities from April 2025.

• In the euro area, policy rate reductions are projected to continue this year, bringing the deposit facility rate to 1¾% by the third quarter of 2025. The decline in Eurosystem bond holdings is expected to continue broadly at the pace observed since early 2025, with no reinvestment of redemptions under either the asset purchase programme or the pandemic emergency purchase programme.

• In Japan, the policy rate is projected to increase gradually to 1¼% by the end of 2026, as core inflation stabilises around 2% and a negative output gap gradually closes. The government bond holdings of the Bank of Japan are expected to decline, as the bank’s monthly purchases are reduced by about JPY 400 billion per quarter. Bank of Japan outstanding assets under the loan support programme are also expected to decrease, as new disbursements to stimulate bank lending are scheduled to end in June 2025, and no rollover is to be made after the beginning of 2026.

• Reductions in policy rates are projected to continue until the second half of 2025 in Canada and Korea, and until the first half of 2026 in Australia and the United Kingdom. Central bank bond holdings are assumed to decline further in Australia and the United Kingdom. In contrast, renewed asset purchases through term repos followed by outright purchases of treasury bills are expected in Canada, allowing the balance sheet size to eventually stabilise as a share of GDP.

Figure ‎1.27. Policy rates are projected to decline further in most advanced economies

Note: The first panel shows the midpoint of the federal funds target range for the United States and the deposit facility rate for the euro area.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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By the end of 2026, real policy rates are generally projected to be within estimated ranges for real neutral rates (Figure 1.28, Panel A) – the real interest rate at which the policy stance is neither accommodative nor restrictive. Inflation is generally projected to be back or close to target at that time, and growing geopolitical fragmentation increases the odds that it eventually settles at target, rather than dropping below it, as in most of the decade following the global financial crisis. This would lead to sustained higher nominal policy rates than before the pandemic, increasing the room for monetary policy manoeuvre through conventional tools in the event of future downturns. Greater room for manoeuvre could also follow if the future neutral rate was to be higher than what current estimates suggest, for instance due to reforms to strengthen productivity and investment, or a larger supply of public debt, to which pressures on public spending (discussed below) and quantitative tightening would contribute (Schnabel, 2025). There is some tentative evidence of a mild rise in neutral rate estimates in major jurisdictions over the past few years (Figure 1.28, Panel B).

Figure ‎1.28. Real policy rates are projected to converge towards neutral levels

Note: In Panel A, the projected real policy rate in 2026Q4 is calculated using the nominal policy rate deflated by annual core inflation over the year to 2026Q4 (except for India and Indonesia, where headline inflation is used). For each jurisdiction, the figure shows a range (min-max) of estimates for the real neutral rate, understood as a longer-run equilibrium real short-term interest rate. The minimum and maximum values come from the following estimates: the Holston-Laubach-Williams (HLW) model estimate (Federal Reserve Bank of New York, 2025) and the Lubik‑Matthes (LM) model estimate (Federal Reserve Bank of Richmond, 2025) for 2024Q4 for the United States; the estimate from term structure models for 2024Q4 and the HLW model estimate for 2024Q3 (Brand et al., 2025) for the euro area; the estimate from term structure models and the HLW model estimate for 2023Q1 (Nakano et al., 2024) for Japan; the HLW model estimate for 2021Q4 (IMF, 2023a) and the LM model estimate for 2023Q3 (Lubik et al., 2024) for the United Kingdom; the lower bound of estimates in nominal terms by the Bank of Canada deflated with the 2% inflation target (Bank of Canada, 2025) and the HLW model estimate for 2024Q4 (Federal Reserve Bank of New York, 2025) for Canada; the range of the estimates for 2022 (Ellis, 2022) for Australia; the Laubach-Williams (LW) model estimate and the modified LM model estimate for 2024Q1 (Do et al., 2024) for Korea; the range of the estimates for 2024Q1 (Castaing et al., 2024) for New Zealand; the range of the estimates for 2024 (Norges Bank, 2024) for Norway; the range of the estimates for 2024Q2 (Banco Central do Brasil, 2024) for Brazil; the range of the long-run average estimates (Banco de Mexico, 2024) for Mexico; the range of the modified LW model estimates for 2024Q1 (Reserve Bank of India, 2024) for India; the range of the HLW model estimate for 2022Q2 and the yield curve model of Basdevant, Björksten, and Karagedikli for 2022Q4 (IMF, 2023b) for Indonesia; and the LW model estimate for 2024 (South African Reserve Bank, 2025) for South Africa. In Panel B, the estimates from the HLW model (Federal Reserve Bank of New York, 2025), LM model (Federal Reserve Bank of Richmond, 2025) and HLW model with convenience yield (Szoke et al., 2024) are considered for the United States. For the euro area and Japan, the estimates are from Brand et al. (2025) and Nakano et al. (2024), respectively. The latest range of estimates are the same as shown in Panel A for these three economies.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Larger debt burdens will bring forward important fiscal policy choices

The fiscal projections for 2025-26 are conditional on announced government measures and OECD assessments of current plans (Annex 1.A). Underlying primary balances are expected to worsen, relative to potential GDP, in several advanced OECD economies in 2025. Improvements are projected the following year, yet only a couple of countries are planning substantial fiscal consolidation in 2026. The projected median change in underlying primary balances over the next two years is approximately zero.

• In the United States, the structural deficit will remain large with underlying primary spending exceeding revenues by 3.4% of GDP in 2026, and the aggregate general government budget deficit exceeding 8% of GDP. Higher tariff receipts will only partly offset revenues lost due to the extension of the 2017 Tax Cuts and Jobs Act, new tax reductions and weaker economic growth. Efficiency measures, including shrinking the federal government workforce, will help slow growth in public expenditure; however, additional spending will reduce net budget savings.

• The euro area’s underlying primary deficit is estimated to shrink by 0.3% of GDP between 2024 and 2026. Modest fiscal consolidation will occur this year, associated with the phase-out of energy crisis support, with little change in the fiscal stance projected for 2026. While high-debt countries including France and Italy are planning budget repair, other economies including Germany are expected to have a fiscal expansion in 2026, with increased spending to upgrade infrastructure and military capability (Box 1.3).

• Japan’s underlying primary deficit is projected to narrow by 0.9% of potential GDP in the two years to 2026. The projection assumes no supplementary budgets are passed in financial years 2025 and 2026. A corporate tax rate increase in 2026 will help finance new spending. The government is planning to increase outlays on disaster preparedness in addition to expenditure on defence and support for families with children.

• Substantial fiscal policy tightening of 1% of potential GDP or more is projected over 2025‑26 in Iceland, Israel, Korea, New Zealand and the United Kingdom. In contrast, fiscal expansions are projected in Denmark (2.8% of GDP), Norway (0.6% of GDP) and Sweden (0.3% of GDP) with all three Nordic countries raising defence spending. Australia’s underlying primary deficit is expected to expand in the next two years, but little change is projected in Canada.

Figure ‎1.29. Public debt determinants in OECD countries

Note: Median values are shown in each year for advanced OECD economies.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Near-term budget pressures from debt service costs and military spending will be compounded in the long run by persisting costs associated with climate mitigation and adaptation and population ageing. Sizeable primary deficits, elevated interest payments and lower growth (Figure 1.29) will keep public debt ratios high and rising in many OECD economies over 2025-26. For the group of OECD countries, the ratio of gross general government debt to GDP is projected to increase by 2.3 percentage points over the two years to the fourth quarter of 2026 (to 114% of GDP). Increases of 1.5 percentage points in the euro area and 5.9 percentage points in the United States are projected, while Japan’s gross public debt ratio is forecast to decline. Where growth is strong enough to withstand additional fiscal headwinds, consolidation efforts should intensify in high-debt countries as monetary policy becomes less restrictive. Other advanced economies have the fiscal room for manoeuvre to increase public spending for some years while running down surpluses or borrowing to finance larger deficits. Amid heightened geopolitical tensions, many countries are fast-tracking defence investments to bolster national security (Box 1.3). Such spending will add to debt burdens in some countries in the second half of this decade. In contrast, some heavily indebted countries – including France, Italy and the United Kingdom – are pressing ahead with budget repair to avoid the risk of abrupt and painful fiscal corrections later (Figure 1.30).

In the near term, governments may also face new calls for additional support in countries confronted with higher trade costs. A first line of defence is to allow automatic stabilisers to operate fully. Targeted, temporary and well-designed support measures (Hemmerlé et al., 2023) could, if necessary, help cushion the initial impact of liquidity shocks felt by companies. Protracted budgetary support to firms facing a lasting loss of external competitiveness should be avoided.

Figure ‎1.30. Substantial fiscal consolidation is projected in some high debt countries

Note: The graph plots projected changes in the underlying primary balance over 2024-26 and public debt ratios in 2024 for 33 advanced OECD economies. “Gross public debt” is gross general government financial liabilities.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Box ‎1.3. Higher defence spending: economic and public finance implications

Defence spending has increased recently in many OECD countries after declining in the three decades following the end of the Cold War. This is evident in Europe, where military expenditure has outpaced growth in GDP since Russia invaded Ukraine in 2022, and also in Israel. Relative to the size of their economies, EU countries in Central and Eastern Europe have invested particularly heavily in their armed forces (Figure 1.31). Poland and the Baltic states have set ambitious goals for future spending, pledging to lift military expenditure to 5% of GDP in years to come. High targets for defence spending, often well above recent outlays, have also been declared in Czechia and the Nordic countries as well as in France and the United Kingdom (Figure 1.32, Panel A). In Germany, where defence spending increased from relatively low levels a few years ago to reach 1.9% of GDP in 2024, constitutional hurdles to higher spending have been removed (see below). While legislated measures leave major spending challenges to future governments in some countries, ongoing defence expenditure is trending higher, in Europe and also in several Asian OECD countries, notably Japan. In contrast, the United States does not have long-term plans to raise the GDP share of its military spending, which is already higher than in most other OECD countries.

Few countries have released detailed information about their medium-term defence spending plans. However, major investments in equipment and infrastructure are considered necessary in many countries to address capability gaps. For instance, European Commission estimates suggest such investments by EU member states could be worth a total of EUR 500 billion over the next decade (1.1% of 2024 GDP).1 While defence investment has increased more rapidly than total defence spending in recent years, personnel costs – a major component of government consumption – typically still make up a larger share of OECD countries’ total defence budgets (39% on average in 2023, compared with 24% for investment).2

Higher defence spending will add to budgetary pressures in many economies. In some, consolidation of other government outlays is expected to create room for higher defence expenditure. This is reflected in budget plans in Estonia, Finland, Latvia, Poland and the United Kingdom. Most of these countries also project budget support from higher revenues. However, few OECD countries have managed to finance large increases in defence outlays in recent years without running down fiscal surpluses or increasing budget deficits. This aligns with historical experience, as substantial additional government borrowing often accompanies the first phases of military build-ups before countries raise taxes (Marzian and Trebesch, 2025). Over the next two years, budget positions are expected to deteriorate in many countries planning higher public spending on defence.

Figure ‎1.31. Defence spending is increasing in advanced economies in Central and Eastern Europe

Defence expenditure

Note: OECD NATO Western Europe includes Belgium, Denmark, Finland, France, Germany, Greece, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden and the United Kingdom. OECD NATO Central-Eastern Europe includes Czechia, Estonia, Hungary, Latvia, Lithuania, Poland, Slovak Republic and Slovenia. For both series, the graph shows unweighted averages for the economies in the group.

Source: SIPRI Military Expenditure database.

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Fiscal rules are changing to accommodate higher defence spending. In Germany, constitutional reform has lifted constraints on borrowing for defence spending ahead of major investments over the coming years. Sweden has departed from a longstanding target of a budget surplus to shift to a balanced budget rule from 2027, enabling higher military expenditure. In parallel to national reforms, the European Commission has invited EU member states able to withstand additional fiscal pressure without threatening debt sustainability to make use of national escape clauses in the Stability and Growth Pact (European Commission, 2025a). Recognising Europe’s “extraordinary” security challenge, national escape clauses – once activated by the Council – would allow deviations from medium‑term budget plans of up to 1.5% of GDP over the next four years, with increased spending to go only on defence.3As at the end of April, 16 member states had decided to request the activation of the national escape clause.4

In countries with limited fiscal space, financial market pressure may curb defence-spending ambitions, even if escape clauses are activated and EU loans help fund defence investments.5 This constraint may be relevant for countries already under the EU Excessive Deficit Procedure, a group that includes France, Poland and Italy, respectively the Union’s second, third and fourth biggest defence spenders in absolute terms based on data published by the Stockholm International Peace Research Institute (SIPRI, 2025). Sustaining higher military expenditure for a long period of time, or even permanently, could force higher-debt countries to confront hard policy trade-offs. While increased borrowing may enable governments to finance large military investments during a transition period, countries unable to sufficiently curb growth in non-military spending may ultimately have to consider raising tax burdens further (Figure 1.32, Panel B). A challenge in monitoring the use of escape clauses will be to ensure that other types of spending, for instance non-military foreign aid, are not reclassified as defence expenditure to circumvent fiscal rules.

Gains to actual or potential growth could help offset the fiscal costs of defence spending but are uncertain and will vary from country to country. In the near term, higher government final expenditure on defence will contribute to demand, employment and incomes, especially if it is financed by borrowing. Some studies suggest fiscal multipliers from military expenditure could be relatively high in advanced economies, with little or no crowding out of private demand in some circumstances (Sheremirov and Spirovska, 2022). Larger near-term output effects are more likely in low-debt countries; when monetary policy accommodates higher government spending; and in countries with established local defence industries (such as France, Germany, Sweden and the United Kingdom).

Recent analyses of the possible economic impact of higher military expenditure in Europe have produced estimates ranging from a 0.5 to 1.5% boost to Europe-wide GDP for defence spending increases of 1.5% of GDP (Ilzetzki, 2025; European Commission, 2025b), with potentially larger effects for economies in recession and if monetary policy responses are limited (Ilzetzki, 2025). In some countries, such as Germany, there are possibilities for automotive manufacturers to produce defence equipment or for defence producers to repurpose factories, buy equipment or hire workers let go by ailing car producers. However, many countries contemplating higher military spending, including some EU member states, have few or no major local producers of military equipment. In the last four years, 64% of arms imports by European NATO states came from the United States (SIPRI, 2025).

The net output effects of defence spending might also differ by type of spending.6 Defence infrastructure projects (for instance, building airfields, docks or storage facilities) or spending on equipment might be associated with relatively high multipliers if, in addition to increased public sector investment, they generate domestic private sector activity and jobs, and rely mainly on locally-sourced materials. Government spending on the armed forces (for instance, additions to military personnel) also contributes to domestic output – directly through public consumption and indirectly via household consumption – and is likely to have larger net effects in economies below full employment.7

Efficient procurement will be essential to support realised improvements in military capability and may help foster innovation spillovers. In Europe, coordinated purchasing between countries should be pursued alongside steps to improve competition and reduce fragmentation in the defence market (Wolff et al., 2025). To the extent that European countries are able to source defence equipment, inputs or services from each other, and stretched availability of supplies does not raise costs, regional multipliers from defence spending could exceed those in individual European countries. Provided inflationary effects are small, positive output effects could be larger, and distributed more broadly across countries, if closely connected economies simultaneously expand their defence spending. Efficient joint procurement could also enhance long‑run cross-border spillovers from investment in defence research and development.8 Historical experience suggests increased defence R&D could support higher private sector productivity (Ilzetzki, 2025), provided increased employment of skilled workers in defence does not exacerbate skills shortages in other industries. Should military spending reallocate labour and capital to less efficient uses, aggregate productivity could be lower (OECD, 2025c).

Figure ‎1.32. Ambitious military spending goals could force tough fiscal policy choices

Note: Goals refer to announced defence spending objectives, whether or not backed by concrete plans, timeframes or legislated measures. Where the goal is expressed as a range (for example, 5-6% of GDP), the bottom of the range is shown. For Germany, newly passed reforms exclude military spending above 1% of GDP from the calculation of the country's debt limit. In the coming years, German defence spending is expected to rise above the current 2% of GDP commitment, but the new government’s full plans are not yet available. Tax revenue data are for 2023.

Source: Tax revenue data are from OECD Revenue Statistics. Defence spending data are from the SIPRI Military Expenditure Database. Defence spending goals are compiled from press releases or secondary sources: Brussels Times, Canadian Government, Danish Ministry of Defence, Dutch Ministry of Defence, Financial Times, Finnish Government, Le Monde, LSM, Luxembourg Government, Politico.eu, Reuters, Radio Prague International, Radio Sweden, Slovenian Government, UK Government.

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1. See European Commission (2024), Opening remarks by President von der Leyen at the joint press conference with President Michel and Belgian President De Croo following the meeting of the European Council of 27 June 2024.

2. Calculated as an unweighted average of results for countries included in the OECD COFOG database.

3. Defence spending will be assessed based on COFOG definitions, which differ from those applied by NATO. The reference year will be 2021, the year before the emergency situation began. For countries subject to an Excessive Deficit Procedure (EDP), escape clause activation would allow deviations from the corrective path under the EDP.

4. The countries include Belgium, Bulgaria, Croatia, Czechia, Denmark, Estonia, Finland, Germany, Greece, Hungary, Latvia, Lithuania, Poland, Portugal, Slovakia and Slovenia (Council of the European Union, 2025).

5. The European Commission has proposed providing loans worth up to a total EUR 150 billion under an instrument called Security Action for Europe (SAFE), an option that could be attractive to countries unable to access market credit on terms as favourable as the Commission.

6. Relatively few studies of multipliers examine the effects of different types of government spending. Findings are mixed among empirical studies comparing multipliers for government investment and consumption. For example, Auerbach and Gorodnichenko (2012) find near‑term output effects of US government investment (a multiplier over 2) that are higher than those for US government consumption (roughly 0.5). Boehm (2020), in a study of OECD countries, finds the opposite holds for short-lived investment spending shocks (ones substantially dissipating within two years) - government investment multipliers are found to be near zero, reflecting lower private investment, while government consumption multipliers are higher (around 0.8). The US study of Haug and Sznajderska (2024) finds that multipliers for government consumption and investment are not statistically significantly different (and around 0.5).

7. A recent study of Central and Eastern European countries finds relatively high multipliers on military personnel expenditures (exceeding unity two years after a spending shock), which is argued to reflect private consumption by military staff (Olejnik, 2023). As in some other papers, multipliers for military expenditures are found to be higher in recessions.

8. Steinwender, Van Reenen and Moretti (2019) study spillovers from defence to private sector R&D within and across countries.

With debt burdens already high in many countries, a step-up in fiscal pressure brings forward hard policy choices. Many of the costs of maintaining larger armed forces, mitigating climate change, adapting to warmer climates, and supporting older populations will coincide and persist for some time. These pressures will exacerbate structural budget imbalances that already exist. To keep public debt sustainable, and preserve buffers to respond to future shocks, countries should pursue fiscal reforms alongside other priorities.

Many advanced economies are looking to curb public expenditure, with reductions in public investment, green infrastructure financing, foreign aid, basic research or cuts to government employment often treated as potential sources of savings. While improving the budget balance in the short run, measures of this sort may erode public service capacity, withdraw support from those most in need and set back long-term objectives, including the need for strong economic growth amid a transition to net zero emissions. Systematic and regular spending reviews and the adoption of new digital technologies could help to improve public sector efficiency while preserving essential public programmes, and limit harm to potential growth by reallocating resources efficiently as priorities shift. Effective targeting of social benefits and pension systems that encourage longer working lives could also help to contain spending (OECD, 2024b; OECD, 2024c). Countries differ markedly in the resources they devote to old age and other social protection expenditure (Figure 1.33), differences that are only partly explained by relative incomes and demographics (Barnes et al., 2025).

Many recently announced and ongoing tax reforms – including measures to broaden consumption tax bases by reducing distortive tax expenditures (Iceland), raise taxation of carbon emissions (Ireland, Portugal) and improve tax collection (Bulgaria, Greece) – could, if carried forward, strengthen structural budget positions while limiting costs to sustainable growth. Other current revenue raising measures, including tariff increases in the United States and direct tax measures in the United Kingdom could, however, be partially offset by adverse impacts on activity. Revenue-raising reforms should generally aim to shift tax systems over time towards less-distortive taxes with fewer exemptions, as it is difficult to alleviate debt burdens without strong economic growth (Pina et al., 2025). There is scope in several advanced economies to raise proportionally more revenue from consumption, environmental and property taxes while relying less heavily on taxing wages (OECD, 2024b; OECD, 2024c).

Medium-term planning is essential to preserve or free up resources for strategically important projects, many of which will weigh on the public finances. Such plans can help avoid excessive debt accumulation and reduce uncertainty about the conduct of fiscal policy. Fiscal rules remain important for the sound management of public finances, even if subject to deviations through escape clauses or other flexibility mechanisms – for instance, to support productive investment or higher defence spending (Box 1.3). Independent fiscal institutions can also play a useful role in assessing the impact of proposed policy changes, overseeing countries’ return to quantitative budget limits, and communicating the need to keep justified departures temporary.

Figure ‎1.33. Government spending patterns vary across OECD countries

2023 or latest year available, per cent of GDP

Note: For each type of government spending, the graph shows the median for countries in the sample (red dots) and the interquartile range (green boxes). Horizontal lines show the sample range.

Source: Barnes et al. (2025); OECD COFOG data; and OECD calculations.

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Emerging-market economies should strive to reduce inflation and fiscal deficits

Policy rate reductions have continued across many emerging-market economies in recent quarters and have started in India, where inflation pressures have gradually abated, creating greater scope for supporting the economy. However, rate reductions have slowed down or been halted since early 2025 in several countries, especially in Latin America, partly due to the persistence of inflation pressures or exchange rate developments. Amid strong growth and rising inflation in Brazil, the policy rate has been raised four times since December 2024 over concerns about a de-anchoring of inflation expectations. In Türkiye, after three consecutive policy rate reductions since December 2024, the policy rate was raised again in April to lower risks of a renewed rise in inflation pressures. Given low inflation, key policy interest rates and reserve requirements have been lowered further in China.

Scope still exists to lower policy rates in most emerging-market economies over the next 18 months, but policy decisions are likely to remain finely balanced. While the projected slowdown of global trade will tend to weaken economic activity, higher tariffs imposed by some countries are likely to put some upward pressure on producer costs worldwide, and higher policy uncertainty may heighten risk aversion in financial markets. Careful calibration of monetary policy will be essential to keep inflation expectations well anchored and to avoid disruptive capital outflows. If necessary, rate reductions may need to be slowed, or even reversed temporarily, to ensure price stability.

The expected pace of policy rate reductions is projected to vary across countries (Figure 1.34):

• China is expected to maintain an accommodative monetary stance to support activity as inflation is likely to remain low, despite some upward pressures from the additional tariffs on trade with the United States.

• In Colombia and Mexico, where policy rates remain elevated, reductions are expected to continue steadily until late 2026, with rates being lowered to 7% and 6.25%, respectively, still somewhat above or close to the upper bound of neutral level estimates. Further small rate reductions are also expected in Chile.

• In India, policy rate reductions are expected to cease by end-2025, while in Indonesia modest rate reductions are projected to continue until late 2026, with inflation projected to return to target and policy rates to broadly neutral levels. The policy rate is already close to neutral level estimates in South Africa where rate reductions are expected to cease by end-2025.

• In Türkiye, where inflation is projected to decline to around 15% by the end of 2026, policy rate reductions are expected to resume over 2025 and 2026.

• In Brazil, given persistent inflation pressures, policy rates are projected to increase further in the coming months to 15%, before a gradual reduction starting from early 2026.

Figure ‎1.34. Policy rates are projected to decline further in most emerging-market economies

Note: In Panel A, the emerging-market economies considered are Brazil, Chile, China, Colombia, Costa Rica, India, Indonesia, Malaysia, Mexico, Peru, the Philippines, Romania, Saudi Arabia, South Africa, Thailand, and Viet Nam. The blue area shows the 10^th, 25^th, 75^th, and 90^th percentiles of policy rates.

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Recent fiscal developments have varied across emerging-market economies. In 2024, fiscal deficits were recorded in most emerging-market economies and rose in many of them (Figure 1.35, Panel A). The expansion of fiscal support in China and the new nationwide free school meal programme in Indonesia weighed on budget balances. In Colombia, the fiscal deficit increased as tax revenue falls outpaced spending cuts, and in Mexico as oil revenues fell. Fiscal balances also worsened in Bulgaria and Romania, due to continued spending pressures in social expenditure and public sector wages. In contrast, the Brazilian fiscal balance improved in 2024, partly due to one-off revenue measures. Budget balances also improved in India and South Africa.

Based on announced policy plans, fiscal balances are projected to improve in most emerging‑market economies in 2025-26 despite slowing growth. Türkiye is expected to continue consolidating as higher consumption taxes increase revenue and public investment is reduced further. Fiscal deficits in Chile, Colombia, Costa Rica, Mexico and Peru are projected to narrow as governments restrain spending and boost tax revenues, although they are projected to fall short of their fiscal targets in Colombia and Peru. India is also expected to consolidate further, partly by streamlining subsidies. In contrast, the fiscal deficit in Brazil is projected to persist in 2025, as there is limited political appetite for raising additional tax revenue, and to worsen in 2026 as growth slows. Fiscal balances are generally expected to improve in most countries in 2026, but the pace of improvement is projected to be relatively modest (Figure 1.35, Panels B and C).

Emerging-market economies face a challenging environment. Amid rising debt and interest payments, they remain vulnerable to rapid shifts in risk sentiment and higher borrowing costs. They need to adjust to the changing global trade environment while preserving investor confidence and avoiding disorderly capital outflows. Countries should strive to meet fiscal consolidation targets, while ensuring that any support to help the economy adjust to changes in trade arrangements is targeted and temporary. In the medium to long-term, countries will need to reconcile fiscal sustainability with higher investment in human and physical capital, including for climate change mitigation and adaptation, and with steps to reinforce social safety nets. Addressing these trade-offs will require fiscal-structural reforms, such as enhancing spending efficiency, including by reducing untargeted subsidies, and improving revenue collection through curbing informality and broadening tax bases. Furthermore, strengthening fiscal institutions, such as fiscal rules and fiscal councils, might also lower financing costs and improve credibility (Alnafrah and Bogatov, 2025; Caldera Sanchez et al., 2024).

Figure ‎1.35. Fiscal balances are expected to improve in most emerging-market economies

Annual change in the ratio of the headline fiscal balance to GDP and in the output gap

Note: The chart is based on central government financial balances for Chile, Colombia, Costa Rica and Thailand, and general government financial balances for all other countries. For some countries data are based on national definitions. Positive changes correspond to improved financial balances or less spare capacity (for instance, smaller deficits or a smaller negative output gap).

Source: OECD Economic Outlook 117 database; and OECD calculations.

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Structural policy reforms need to be enhanced to support trade and boost investment

Governments need to find ways of working together within the global trading system to reduce policy uncertainty and avoid a ratcheting up of retaliatory trade barriers 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 (Figure 1.36; OECD, 2025b).

Figure ‎1.36. Opportunities exist to raise living standards by lowering trade barriers

Simulation of a reduction of 1.5 percentage points in average effective tariff rates in all countries

Note: Based on a reduction relative to the tariff rates assumed in the current baseline.

Source: OECD calculations using the NiGEM global macroeconomic model and the OECD METRO model.

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Efforts to prevent 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 aligned regulatory standards on key intermediate production inputs between countries. This includes ongoing efforts to harmonise regulations between countries in the European Union. There is also additional scope to better align regulatory standards between sub-national jurisdictions. For example, in Canada, further eliminating differences in product and labour regulations and technical standards between provinces would better allow goods and services to flow to where they are most needed.

Reforming trade facilitation procedures could also reduce trade costs and support greater diversification and depth in trade. Many countries have recently improved such procedures, by enhancing cooperation between border agencies both domestically and across countries. OECD estimates suggest that trade costs have declined by up to 5% over the last decade due to improvements in the efficiency of border processes, with the strongest effects in lower-income and lower middle-income economies (OECD 2025d; Figure 1.37). Further ambitious reforms to border agency co-operation, efforts to enhance the implementation of regulatory frameworks for trade facilitation, and to automate and simplify procedures could reduce delays and compliance costs and improve supply chain efficiency, potentially reducing trade costs by up to a further 12 percentage points (OECD, 2025d). Such improvements would help to boost the ability of exporters to find new markets and deepen existing trade relationships.

Figure ‎1.37. Trade facilitation improvements lower trade costs

Note: The figure presents the trade cost implications of fully implementing trade facilitation reforms as measured by the OECD’s Trade Facilitation Index, based on observed changes between 2012 and 2022, and hypothetical changes. Analysis using trade costs (manufacturing and agriculture) from the UNESCAP – World Bank database for the period 2012-22. Calculations based on methodology in Sorescu and Bollig (2022).

Source: OECD (2025d).

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Lower barriers to trade in services would also promote trade flows. The OECD Services Trade Restrictiveness Index highlights the continued challenges of regulatory fragmentation and uneven conditions in access to services markets across countries (Figure 1.38, Panel A). This creates an uneven playing field which hampers trade in services as well as goods, because many services, such as logistics, are also crucial for global trade in goods. The pace and magnitude of services sector reforms were moderate in 2024 compared to 2023, with higher restrictions in all 22 services sectors and meaningful trade liberalisation in only a handful of sectors (OECD, 2025e). Ambitious policy reforms reducing services trade restrictiveness, equivalent to closing half the distance between current and best practice, could result in trade costs falling by around 11% in services sectors (OECD, 2024d; Figure 1.38, Panel B), with additional productivity benefits for manufacturers using services. This would be a significant potential offset to higher tariffs.

Further efforts to support the digital delivery of services could also yield benefits. Raising digital connectivity between countries can support trade in goods as well as in services. However, digital services policy remains fragmented and increasingly restrictive. The OECD Digital Services Trade Restrictiveness Index shows that rising trade restrictions on digitally enabled services between 2014 and 2023 particularly affected access to communication infrastructure and connectivity (OECD, 2025e). Governments need to find an appropriate balance between safeguards and ensuring adequate competition in digital services. Trade tends to rise fastest when policies to lower trade facilitation costs are undertaken alongside significant improvements in the digital regulatory framework, highlighting the importance of carefully designed reforms to maximise the benefits for trade performance and competitiveness.

Figure ‎1.38. Improving services regulation would boost trade growth

Note: Panel A shows the OECD Services Trade Restrictiveness Index (STRI). The STRI indices take values between zero and one, one being the most restrictive. The STRI database records measures on a most favoured nation (MFN) basis towards third countries. The indices are based on laws and regulations made public by 31 October 2024 and in force on 31 December 2024. The STRI regulatory database covers the 38 OECD Members, Brazil, China, India, Indonesia, Kazakhstan, Malaysia, Peru, the Philippines, Singapore, South Africa, Thailand, Russia, and Viet Nam. The OECD aggregate is a simple average of all OECD members. Panel B shows the implications for services trade costs if all countries close 50% of the gap in their Services Trade Restrictiveness Index (STRI) score with the best-performing countries. All estimates correspond to the median for 50 countries. Calculations based on the methodology in Benz and Jaax (2020).

Source: OECD (2025e); and OECD (2024d).

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Rising protectionism and weak growth prospects also reinforce the need for governments to promote productivity and improve living standards through undertaking ambitious structural policy reforms. As discussed in Chapter 2, a strong focus should be policies to promote business investment that supports innovation and stronger growth in labour productivity. Investment prospects are now being damaged by the significant rise in policy uncertainty and this follows a marked slowdown in the pace of business investment in many economies since the financial crisis (Figure 1.39, Panel A). Only a small portion of this investment slowdown can be explained by weaker demand growth. Firms across OECD economies have increasingly invested in digital assets (Figure 1.39, Panel B), but the impact on net investment rates has been more than offset by weaker growth in traditional forms of capital investment and higher depreciation. Housing and public investment have also slowed in many countries, contributing to deteriorating housing affordability and public infrastructure.

Figure ‎1.39. Business investment gaps are large across OECD economies

Note: In Panel A, the investment gap is calculated as the shortfall relative to predicted investment from a simple accelerator model that relates real business investment growth to its own lag and to current real output growth. Predicted real business investment is calculated from 2008 to 2023 as the fitted values from a model using actual growth rates of GDP and lagged investment. The overall shortfall in real business investment relative to the pre-GFC trend in 2023 is then decomposed into a part that is explained by the model, interpreted as demand (calculated as trend investment minus predicted investment) and an unexplained part, or “gap” (calculated as predicted investment minus actual investment, as a per cent of predicted investment). In Panel B, ICT machinery includes both computer hardware and telecommunications equipment. ‘Other’ includes Australia, Canada, Israel, Japan and the United Kingdom. OECD refers to the weighted average of 32 OECD countries for which data is available, with weights based on GDP PPP.

Source: OECD Economic Outlook 117 database; OECD National Accounts database; and OECD calculations.

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Weakening business investment has reflected structural factors in many economies. Despite rising profits, firms have shied away from fixed capital investment in favour of accumulating financial assets and returning funds to shareholders (OECD, 2025a). Across the OECD, the corporate sector has moved from being a net borrower to a net lender on aggregate since the financial crisis. This has coincided with an increase in required rates of return on investment, with the gap between the hurdle rates that businesses apply to investment decisions and capital costs having widened across countries (Figure 1.40). Identifying the factors behind sticky hurdle rates is fundamental for policymakers aiming to revive business investment growth. Elevated uncertainty, declining business dynamism and perceived difficulties in funding future investment in intangible assets are all factors that have been identified as playing a role in OECD economies (see Chapter 2).

Against this backdrop, there are a range of structural policy reforms that can help revive business investment growth (see Chapters 2 and 3). Efforts to assuage policy uncertainty are key, as they would allow businesses to reduce the risk-premia they incorporate in hurdle rates. This is relevant across various policy dimensions, with specific approaches including conducting trade policy through a transparent and rules-based approach, outlining and implementing credible fiscal strategies, reducing complexity and improving transparency in regulatory policies and taking further credible steps to mitigate and adapt to climate change.

Figure ‎1.40. The gap between financing costs and hurdle rates has increased

Note: Predicted values for firms’ perceived cost of capital and hurdle rates based on information provided during corporate earnings calls, investor conferences, and similar events. The description of data collection and computation can be found in Gormsen and Huber (2023). Panel A presents a time series representing the average of the countries listed in Panel B.

Source: Gormsen and Huber (2023).

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Policies that promote business dynamism would also incentivise firms to innovate and invest as they strive to stay ahead of competitors. In many nascent industries, such as artificial intelligence, measures are often needed to lower barriers to firm entry and guard against firms building monopolistic positions. Given signs of reduced business dynamism in OECD economies (Calligaris, et. al. 2024), efforts to reduce the costs of regulations to businesses are needed. For example, there is significant scope to lower barriers to firm entry in capital-intensive network sectors, with new OECD simulations suggesting that deregulation in more highly regulated economies towards the regulatory levels of their least regulated peers is associated with an increase in the potential capital stock of up to 1.5% (Andrews et. al. 2025). Many countries also still lack adequate rules guaranteeing the transparency and accountability of lobbying activities. This regulatory void can benefit incumbents and well-funded corporations, enabling them to shape rules and the implementation of these rules in their favour at the expense of new entrants. Less punishing insolvency regimes and less prescriptive land use regulations are other key policy areas for promoting business dynamism, through their influence in supporting entrepreneurship and the growth of new businesses. Ensuring the availability of skilled labour will also be important for the expansion of high potential firms, both through a focus on lifelong learning policies and structural reforms that lower frictions in labour markets, such as reducing the prevalence of unnecessary non-compete clauses.

Measures that facilitate better access to finance, especially for funding hard-to-collateralise intangible assets, can promote current investment spending by reducing the need for firms to save for future intangible investment spending. Improved depth of capital markets would support a more diverse range of funding options and promote competition between lenders. In Europe, making further progress on implementing the Savings and Investments Union will be important in this regard. Developing certain segments of capital markets that are more well-suited to funding intangibles than traditional banking systems may require some public financial support as well as regulatory changes. While remaining attuned to potential implications for financial stability, examples include adjusting regulatory restrictions on the investment activities of pension providers, public investment in venture capital markets and reducing administrative requirements on fintech lenders.

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Annex 1.A. Policy and other assumptions underlying the projections

Fiscal policy settings for 2025-26 are based as closely as possible on legislated tax and spending provisions and are consistent with the growth, inflation and wage projections. Where government plans have been announced but not legislated, they are incorporated if it is deemed clear that they will be implemented in a shape close to that announced. It is assumed that EU countries generally adopt fiscal policy adjustments which are consistent with the reformed Stability and Growth Pact, apart from those member states where planned fiscal expansions are likely to require the activation of national escape clauses.

Projections for the EU countries account for spending financed by the NextGenerationEU (NGEU) grants and loans, based on expert judgments about the distribution of spending across years and different expenditure categories and informed by officially announced plans where available. NGEU grants are assumed to be budget neutral, and increase both capital tax and transfers receipts and government expenditure. In addition, positive net one-offs are added in order to reflect the discretionary stimulus associated with those grants, as measured by changes in underlying primary balances.

For monetary policy, the assumed path of policy interest rates and unconventional measures represents the most likely outcome, conditional upon the OECD projections of activity and inflation. This may differ from the stated path of the monetary authorities. In the euro area, 10-year sovereign spreads relative to Germany are assumed to remain constant over the projection period at levels close to those observed in the first half of May.

The projections assume unchanged exchange rates from those prevailing on 9 May 2025: one US dollar equals JPY 145.2, EUR 0.89 (or equivalently one euro equals USD 1.13) and 7.24 renminbi.

The price of a barrel of Brent crude oil is assumed to remain constant at USD 60 until the end of 2026. The TTF natural gas price is assumed to remain constant at EUR 35 MW/h until the end of 2026. Other commodity prices are assumed to be constant over the projection period at their average levels from April 2025.

A technical assumption is made that the tariffs being applied as of mid-May 2025 remain in place throughout 2025 and 2026. It is also assumed that some disruptions to shipping in the Red Sea persist through 2025 and 2026.

The cut-off date for information used in the projections is May 27, 2025.

OECD quarterly projections are on a seasonal and working‑day‑adjusted basis for selected key variables. This implies that differences between adjusted and unadjusted annual data may occur, though these in general are quite small. In some countries, official forecasts of annual figures do not include working-day adjustments. Even when official forecasts do adjust for working days, the size of the adjustment may in some cases differ from that used by the OECD.

Notes

← 1.  Effective tariff rates weight the rise in a given tariff line with the share those imports constitute; for the purposes of these calculations 2024 US Census Bureau data are used.

← 2.  Heightened uncertainty will also reduce trade through a variety of channels, including through the effect on investment and raising the costs of inventories (Novy and Taylor, 2020; Limao and Maggi, 2015).

← 3.  Corporate debt (including both loans and bonds) in advanced economies declined to USD 54 trillion (94% of GDP) in 2024, down from a peak of USD 62 trillion (108% of GDP) in 2020. Corporate debt (broadly defined) in emerging economies remained elevated at USD 39 trillion (91% of GDP) in 2024, down from the record levels observed in 2020 (106% of GDP). Estimates are based on data on credit to the non-financial sector from the Bank for International Settlements.

← 4.  The share of high-yield bond issuance in total bond issuance by non-financial corporates increased from 16% in 2009 to 22% in 2023, and the average share of leveraged loans in the total syndicated loans of non-financial corporates increased from an average 38% between 2000 and 2012 to 43% between 2013 and 2024.

← 5.  The experience from the US-China 2018-19 trade tensions suggests that companies exposed to higher tariffs have lower investment, employment and productivity growth (Amiti et al, 2025; Chor and Li, 2021).

← 6.  At end-2023, 53% of all investment grade bond issuance by non-financial companies was rated BBB.

← 7.  Both current levels of concentration and developments over time in equity and corporate bond markets differ substantially across countries.

← 8.  The world’s 100 largest corporate bond funds represent well over a third of global corporate bond assets.

← 9.  Based on aggregate investment fund assets data from Bloomberg. In 2024, the passive share is 59% for equity funds and 38% for fixed income funds.

← 10.  Although volatility in equity and bond markets and trading volumes has been exceptionally high amid forced cash raising, market functioning has remained orderly (BoE, 2025).