A trade war is a situation in which countries impose tariffs or other restrictions on imports from each other. This often happens in an attempt to protect local industries from foreign competition. But it can also cause significant disruptions to global markets, raise consumer prices, and strain international relations.
This trade war scenario assumes that the US and China impose a comprehensive set of tariffs, affecting a wide range of products from steel and aluminum to solar panels and washing machines. It also assumes that the EU and other trade partners respond with a corresponding set of tariffs on American goods, targeting everything from soybeans and pork to aircraft and weapons.
The resulting trade war would lead to significant losses for both the US and China. Within a year, US exports would fall by nearly 17 percent, while economic output would shrink by 1.7 percent. Domestic prices would increase by about 5.5 percent, driven by higher costs for inputs and the loss of access to low-cost suppliers.
In addition, both economies would face slower growth in consumption and investment, as monetary stimulus wears off and financial stress rises. And the world economy would suffer from lower exports and reduced foreign investment in emerging markets targeted by retaliatory tariffs. The trade war scenario is particularly bad news for China, which could see its growth slow from 6.7 percent this year to 5.2 percent next year. This reflects not just the impact of lost exports, but also a more cautious approach to real fixed investment by domestic and foreign investors.