In a recent address, Bank of Canada Governor Tiff Macklem highlighted the profound and lasting economic repercussions that a potential trade war with the United States could have on Canada. He emphasized that such a conflict would not only stifle economic growth but also lead to a permanent reduction in the nation’s output.
Projected Economic Impact
Governor Macklem referenced the Bank’s January projections, which, under normal conditions without tariffs, anticipated a growth rate of approximately 1.8% for both 2025 and 2026. However, in a scenario where tariffs are imposed, the Canadian economy could experience a contraction of nearly 3% over two years relative to the baseline. This stark contrast suggests that the introduction of tariffs would effectively nullify economic growth during this period.
Structural Economic Changes
Unlike the temporary downturn caused by the COVID-19 pandemic, which was followed by a swift recovery, a trade war-induced recession would result in a “permanently lower” level of economic output for Canada. Governor Macklem explained that while the economy eventually might return to its current growth rate, the overall output level would remain diminished, indicating a fundamental structural shift rather than a transient shock.
Inflationary Pressures and Monetary Policy Challenges
The imposition of tariffs would likely lead to increased costs for imported goods, thereby exerting upward pressure on inflation. The Bank of Canada faces the complex task of balancing these inflationary pressures against the anticipated decline in demand. While lowering interest rates could support demand, it might also exacerbate inflation. Conversely, raising rates to control inflation could further suppress economic activity. This delicate balancing act underscores the limited capacity of monetary policy to address simultaneous supply and demand shocks.
Policy Implications and Future Outlook
In light of these challenges, Governor Macklem reaffirmed the Bank’s commitment to its 2% inflation target, emphasizing the importance of maintaining price stability amid potential trade disruptions. He also indicated that the upcoming 2026 review of the monetary policy framework would focus on refining core inflation measures and understanding the interplay between monetary policy and the housing market.
The prospect of a trade war introduces significant uncertainty into Canada’s economic landscape. Policymakers, businesses, and consumers must prepare for potential structural changes that could have enduring effects on growth, inflation, and overall economic well-being.
