There is no shortage of ideas about what to do about potential U.S. tariffs, but we are also still trying to get a handle on what the impact of tariffs and counter tariffs might be.

We’ve presented some preliminary estimates of the impact on Alberta and we will be publishing a new forecast in mid-March.

Under the proposed Trump tariffs, our preliminary estimate is for Alberta’s economy to experience a significant reduction in economic growth with real output expanding by just 0.5% this year instead of 2.5%. Weaker growth persists into next year, with the level of real GDP lower than the base case by nearly 3% in 2026.

On Friday, the Bank of Canada’s Governor Tiff Macklem shared the central bank’s updated estimates of how Canada’s economy would perform under a protracted trade war with the U.S. His remarks revolved around three related (and rather gloomy) observations:

1. The economic consequences for Canada would be “severe” and “structural”

The Governor pointed to the severity by noting that, “[in the Bank’s] January projection with no tariffs, we forecast growth of about 1.8% in both 2025 and 2026. But in the tariff scenario, the level of Canadian output falls almost 3% over two years [relative to the base case]. That implies tariffs would all but wipe out growth in the economy for those two years.”

What’s more, the impact would, unlike the COVID shock, result in a “permanently lower” level of economic output in Canada. “In the pandemic, we had a steep recession followed by a rapid recovery as the economy reopened. This time, if tariffs are long-lasting and broad-based, there won’t be a bounce-back. We may eventually regain our current rate of growth, but the level of output would be permanently lower. It’s more than a shock—it’s a structural change.”

This is evident in this chart we borrowed from the account of the Governor’s remarks:

The Bank’s trade conflict scenario assumes the tariffs outlined in the President’s Executive Order of February 1 are imposed (25% on non-energy goods exports and 10% on energy exports to the United States) plus Canadian retaliatory tariffs. The result is an initial decline in GDP followed by growth that remains about 2.5% lower than in the base case.

2. Stagflation will set in

According to the Bank’s modelling, which takes into account a wide range of variables including export demand, the exchange rate, supply chain integration, production levels, employment, business investment and household income, the friction from a trade war ends up causing the Canadian economy to slow while also causing prices to rise. As Macklem puts it, “a trade conflict would push up prices, even as demand weakens. ”This is the dreaded stagflation scenario in which you get the worst of both worlds: stagnant output and elevated inflation.

3. Monetary policy could be stuck between a rock and a hard place

Macklem also addresses what the Bank can do about a trade war and the answer is not very encouraging. According to the Governor, “with a single instrument—our policy interest rate—we can’t lean against weaker output and higher inflation at the same time.”

This means that, if the spike in prices is temporary, the Bank can look past it and avoid having to raise interest rate to rein it in back in. Our view is that, assuming longer-term inflation expectations remain anchored, the Bank will lean toward more aggressive rate cuts in response to a trade war.

If, however, If there are signs the price growth is not temporary, the Bank is in a really tough spot. Its mandate to keep inflation under control would point to interest rate increases, but doing so would further weaken demand.

And circling back to the “structural” change that a protracted trade war could cause: “Long-lasting tariffs mean lower potential output because our economy works less efficiently. Monetary policy cannot restore the lost supply. At most, it can smooth the decline in demand” [emphasis added].

Given that monetary policy can only do so much, the Bank also talks about “strengthening Canada’s economic union” with a “concerted focus on productivity.”  Removing barriers to internal trade, as we’ve discussed,  was cited as one path forward.

Answer to the previous trivia question: The Smoot–Hawley Tariff was signed by President Hoover on June 17, 1930.

Today’s trivia question: In which 1986 film starring Matthew Broderick does a high school economics teacher reference the Smoot–Hawley Tariff?