A China Shipping container is seen at the port of Oakland, as trade tensions escalate over U.S. tariffs with China, in Oakland, California, U.S., April 10, 2025. REUTERS/Carlos Barria/File Photo

U.S. Economy Contracts for First Time in Three Years Amid Tariff-Driven Trade Imbalance

May 1, 2025

The U.S. economy shrank in the first quarter of 2025 for the first time in three years, with a surge in imports—spurred by businesses seeking to preempt tariff hikes—emerging as the primary cause. The 0.3% annualized decline in gross domestic product (GDP) highlights the disruptive effects of President Donald Trump’s trade policy, introduced amid heightened economic and political uncertainty.

Trade Surge and Economic Distortions

According to the Commerce Department’s advance estimate, imports rose at a staggering 41.3% annualized rate—the largest increase since the third quarter of 2020—outpacing exports and driving the goods trade deficit to a record high. The trade gap reduced GDP by a record 4.83 percentage points.

This import spike was attributed to companies stockpiling goods, particularly consumer and capital goods, ahead of new tariffs under Trump’s so-called “Liberation Day” policy, which raised duties on Chinese imports to 145%. The Bureau of Economic Analysis also noted abnormal purchases of nonmonetary gold and silver that contributed to import distortions but did not directly count toward GDP.

Domestic Spending and Business Investment

Despite the overall contraction, key indicators of domestic demand showed resilience:

• Consumer spending grew at a 1.8% rate, a slowdown from 4.0% in the fourth quarter, largely driven by healthcare, housing, and nondurable goods.
• Final sales to private domestic purchasers—a measure excluding trade, inventories, and government spending—expanded at a solid 3.0% rate.
• Business investment in equipment surged, notably in information processing and transportation, rising at a 22.5% pace.

However, economists cautioned that much of this activity may also reflect preemptive spending ahead of tariffs.

Inflation and Labor Market Indicators

The labor market showed signs of cooling:

• Wages and salaries rose 0.8% in Q1, down from 1.0% in Q4 2024.
• Inflation pressures intensified early in the quarter but eased by March. The core Personal Consumption Expenditures (PCE) price index was flat in March after rising 0.5% in February.

These developments are expected to influence the Federal Reserve’s upcoming rate decision, with many analysts predicting no change in interest rates next week.

Government Spending and Inventories

Federal government spending declined, weighed down by budget cuts, agency shutdowns, and mass dismissals instituted by the Trump administration. Conversely, inventories rose sharply, contributing 2.25 percentage points to GDP as businesses stocked up in anticipation of tariff effects. This buildup, however, is expected to become a drag on future quarters.

Political and Market Reactions

President Trump downplayed the contraction, blaming former President Joe Biden while highlighting domestic demand strength. However, Democrats criticized the administration’s economic leadership. Senate Democratic Leader Chuck Schumer called for Trump to dismiss his economic advisers and reverse course.

Markets responded negatively: U.S. stocks fell, Treasury yields declined, and the dollar strengthened. Business and consumer sentiment remained weak, with airlines withdrawing 2025 financial forecasts due to demand uncertainty.

Outlook and Risks

Economists forecast a potential rebound in Q2 as the trade imbalance corrects, but they warn that ongoing tariff-related uncertainty and higher consumer prices could push the economy into stagflation—a period of stagnant growth coupled with inflation.

“Uncertainty and higher taxes—tariffs are a tax—will drag GDP growth back into the red by the end of this year,” said Carl Weinberg, chief economist at High Frequency Economics.