{"id":2850,"date":"2025-01-22T05:26:24","date_gmt":"2025-01-22T05:26:24","guid":{"rendered":"https:\/\/www.rbc.com\/en\/economics\/2025\/01\/22\/a-playbook-for-how-to-measure-a-tariff-shock-in-canada\/"},"modified":"2025-03-26T04:54:39","modified_gmt":"2025-03-26T04:54:39","slug":"a-playbook-for-how-to-measure-a-tariff-shock-in-canada","status":"publish","type":"post","link":"https:\/\/www.rbc.com\/en\/economics\/canadian-analysis\/featured-analysis\/insights\/a-playbook-for-how-to-measure-a-tariff-shock-in-canada\/","title":{"rendered":"A playbook for how to measure a tariff shock in Canada"},"content":{"rendered":"

U.S. President Donald Trump has taken office, and understandably, there is growing concern about what threatened American tariffs could mean for the Canadian economy.<\/p>\n

Economists have a head start this time around\u2014it isn\u2019t our first pass at assessing the impact of tariffs on the modern Canadian economy. For example, we learned a lot from tariffs on softwood lumber<\/a> in 2017, and steel and aluminum<\/a> tariffs in 2018. Now, however, the size and scope of tariffs could dwarf those previous experiences\u2014and, the magnitude and details could make the past far less prophetic.<\/p>\n

As Canadians prepare for the potential economic impact, it is very tempting to want to give a single figure \u201chit\u201d to growth or jobs from a threatened tariff to neatly summarize the narrative. But, the reality of a tariff shock is trickier and messy. U.S. tariffs in the size that they have been floated, or even, a fraction of that size, could filter into the Canadian economy immediately, significantly and then, persistently for many years (they would also be damaging to the U.S. economy). Just how much and through what main channels would depend on a massive range of fluctuating and, sometimes, unpredictable variables\u2014including the size of the tariff and goods impacted, the Canadian dollar\u2019s reaction, how central banks may choose to respond, and how governments may choose to retaliate or provide support to industries impacted, among other factors.<\/p>\n

As the threat of tariffs loom over Canada, and households, businesses and policymakers manage through this next chapter, they will need more than a simplified round number to understand how the economy will evolve. They will collectively need a playbook on how tariffs filter through the economy, over what timelines and through what channels. Here is a framework that will guide economists\u2014and everyone else\u2014through the complicated path ahead.<\/p>\n

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Seven ways a U.S. tariff would likely flow through Canada\u2019s economy<\/h2>\n
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    Before the tariff is applied\u2026<\/strong><\/p>\n<\/p>\n<\/div>\n<\/li>\n

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    1.\tUncertainty about the future could result in Canadian business activity and investing pausing<\/strong> as companies struggle to make big plans and investments without clarity on their future environment.<\/div>\n<\/li>\n
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    2.\tAmericans are likely to stock up on impacted Canadian goods, temporarily boosting growth on both sides.<\/strong> If a tariff is announced, but doesn\u2019t come into effect for a period of time, past experience suggests that companies can (and do) stockpile inventory ahead of a price increase. That has the effect of initially bolstering trade activity (and growth) on both sides of the border, but at the expense of future growth. This can also occur under threatened (but not realized) tariffs.<\/div>\n<\/li>\n
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    Once the tariff is applied…<\/strong><\/p>\n<\/p>\n<\/div>\n<\/li>\n

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    3.\tThe price for Canadian goods rises for American importers, and demand for these goods likely declines. How much it declines depends on multiple factors.<\/strong><\/p>\n
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      a.\tHas the currency stabilized to make Canadian goods cheaper?<\/strong> A weaker Canadian dollar (and a stronger U.S. dollar) can offset some of increased costs created by the tariff for the American importer.<\/p>\n<\/li>\n

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      b.\tAre there U.S. (or other) lower-cost goods that can be substituted for the tariffed Canadian product?<\/strong> The hit to demand will be larger if there\u2019s an option to alternate to a cheaper product. If not, demand remains more resilient.<\/p>\n<\/li>\n

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      c.\tWho is importing the good and can they absorb the cost?<\/strong> Producers, for example, might have sufficient profit margins to absorb higher costs without passing it onto consumers. Consumers may also be able to absorb a price increase (pricing power) without cutting back. The opposite can also be true, zapping demand.<\/p>\n<\/li>\n<\/ul>\n<\/div>\n<\/li>\n

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      4.\tRetaliatory measures may come into place <\/strong> at some point in this process, perhaps before or after the U.S. tariff is imposed. Retaliatory measures bring further economic implications, likely dampening growth and increasing inflation for Canadians, but the size and scope of the measures result in a range of economic impacts in turn.<\/div>\n<\/li>\n
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      5.\tSecondary industries could start to feel the impact of reduced activity in the export sector,<\/strong> weighing on employment in areas of the economy that didn\u2019t have tariffs directly imposed. For example, consider a town that sees auto production pull back significantly, reducing employment in a plant that has knock on effects on the town\u2019s restaurants, movie theatres and other services.<\/div>\n<\/li>\n
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      6.\tThe Bank of Canada response to tariffs can support or further dampen growth.<\/strong> Tariffs represent a complicated setup for central banks. They tend to increase costs (inflationary), but they also weaken an economy (deflationary). Most central banks have been clear that they are less likely to respond to inflation directly generated from tariffs, because they increase the price once, and then no longer contribute to year-over-year inflationary pressures. However, the follow on impact of rising inflation driven by a drop in demand could be more damaging. How the Bank of Canada will respond to this environment is not clear, but it has implications for other sectors like housing that could provide an offset from further interest rate cuts.<\/div>\n<\/li>\n
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      7.\tFiscal support may soften the economic impacts of a tariff shock and affect near-term forecasts.<\/strong> How federal and provincial governments respond could create further variability in the outlook. Near-term policies designed to support sectors and employees impacted by tariffs could help lessen the initial pain, but it\u2019s likely that more support would be needed to bolster the economy\u2019s longer term growth trajectory. Unlike the global financial crisis and the Covid-19 pandemic, Canada wouldn\u2019t be part of a global fiscal expansion in concert with its peers. It would likely be responding to a Canada-specific shock that would likely weaken its place relative to its fiscal peers . This could bring Canada\u2019s triple-A credit rating into debate as well, leaving the government to navigate difficult choices about its fiscal position.<\/div>\n<\/li>\n<\/ul>\n<\/div>\n

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      Five assumptions we can make about tariff shocks without knowing the details yet<\/h2>\n

      The tentacles and timelines of tariff shocks mean the paths the economy could take is wide, but there are several guideposts we can follow with high certainty even if we lack clarity on what is a threat or a policy ahead.<\/p>\n

      1.\tTrade-sensitive industries are the most vulnerable<\/h3>\n

      Tariffs are effectively taxes on trade flows (the movement of goods), and not production. So, it\u2019s reasonable to assume the industries that are typically the most vulnerable are those that trade a lot relative to their production base.<\/p>\n

      Decades of free trade have resulted in tightly integrated cross-border industrial supply chains with the U.S., where intermediate goods often cross the border multiple times at different stages of production. Therefore, these goods are potentially subject to tariffs multiple times during the production process.<\/p>\n

      The auto sector is the poster child of this kind of integration. Canadian exports and imports of motor vehicles to and from the U.S. are a multiple of 10 relative to total Canadian GDP in the sector. But, more than 60% of the Canadian manufacturing sector has U.S.\/Canada trade flows that are at least twice their domestic Canadian production base.<\/p>\n