Trade war escalates: What’s next for Canada policy
Bank of Canada Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers leave a press conference at the Bank of Canada in Ottawa on Wednesday, March 12, 2025. THE CANADIAN PRESS/Sean Kilpatrick
We’re now in the second week of the Global Trade Wars, and the contours of a new economic order—and Canada’s potential policy response—are beginning to take shape as the U.S. constructs a tariff wall around the world’s largest economy. Let’s start with a quick recap of this week’s developments.
The U.S. imposed sweeping new tariffs on March 12—25% on all steel imports and 10% on all aluminum imports across all countries. These replace previous tariffs but with a broader scope and no country exemptions, making Canada the most affected exporter. Canada retaliated with additional 25% tariffs on about $30 billion of U.S. goods—including steel, aluminum, computers, and sports equipment—bringing the total value of U.S. exports impacted by Canadian retaliatory tariffs to about $60 billion. For a rundown of last week’s tariff measures, see here.
The EU also unveiled a US$28 billion retaliatory tariff plan in response to the U.S. steel tariffs, including a 50% duty on Kentucky bourbon starting April 1. In turn, Trump threatened a 200% retaliatory tariff on European wine, champagne, and spirits in response to the EU’s retaliation.
There was also a mini trade dispute with Ontario. On March 10, Ontario imposed a 25% surcharge on electricity exports to the U.S. in retaliation for the U.S.’s imposition of 25% tariffs on all Canadian goods. The next day, Trump threatened to double steel and aluminum tariffs (to 50% and 25%, respectively) in response, prompting Premier Doug Ford to suspend the surcharge.
Policy contours
With tariff walls rising, we are also beginning to see some policy contours emerge, with the Bank of Canada leading the way. At its policy decision on Wednesday, Canada’s central bank cut interest rates for the seventh consecutive time (the Bank of Canada has prescheduled policy decisions every six to seven weeks), citing tariff concerns. But it also used the policy decision to reinforce some of its thinking about how things could unfold and how policymakers will respond.
A few observations:
The key message from the bank is that the economy is headed into a period of both slow growth (due to U.S. tariffs) and rising prices (due to both the rising costs associated with trade uncertainty and the direct effects of retaliatory tariffs).
While the central bank’s instinct is to continue cutting rates to offset slowing growth, rising inflation will limit its ability to do so. It’s the central bank equivalent of being caught between a rock and a hard place.
The bottom line is that the central bank will only be able to go so far in its bid to offset the economic slowdown.
The Bank of Canada is implicitly signaling that it has learned from its mistakes during the COVID response when it underestimated the impacts of supply constraints and overstimulated the economy. The trade war is similar—it’s both a demand shock and a supply shock (i.e., an environment where costs are rising). Governor Tiff Macklem cited three major channels driving prices higher: the direct impacts of retaliatory tariffs, the indirect impact of a weaker Canadian dollar (which drives up import costs) and growing trade uncertainty.
“The uncertainty itself is adding costs. Businesses are looking for new suppliers, they are holding extra inventory, they are looking for new markets for their goods, that all entails new costs. So there are a number of new costs that businesses are facing and ultimately those will get passed through to the prices that Canadians face.”
Fiscal policy
The dual-shock nature of a trade war with the U.S. also complicates fiscal policy because the tools that address supply constraints differ from those that boost demand. Just like monetary policy, a supply shock, in theory, limits how much the federal government can lean on additional stimulus. (To be sure, those limitations didn’t stop the Liberals during Covid).
If we are in a rising cost environment in the short term because of these trade disruptions, extra demand could just fuel inflation and produce a stagflationary environment. But even if supply weren’t constrained, households could simply save any handouts rather than spend them—just as they did during the COVID response.
All to say, the dual-shock nature of the trade war caps how much government spending there could be, and what that spending can achieve.
This has two implications:
The fiscal policy focus in the short term should be on targeted and temporary relief.
In the medium term, fiscal policy will likely need to focus on structural adjustments—market diversification, infrastructure, etc.
Political implications
As long as fiscal policy remains targeted and temporary, the short-term response won’t be politically controversial. All parties will largely be on the same page. I doubt newly minted Prime Minister Mark Carney would replicate the excesses of the Trudeau government in his stimulus package should he win the next election. I also doubt the Conservatives would oppose temporary support for workers or industries impacted by the trade war.
The bigger and more important debate will be around medium-term plans—the federal government’s role in influencing the structural changes needed in the economy. There’s a lot of talk about the next election being about who’s best positioned to “take on” Trump. But given that trade walls appear to be rising regardless of negotiations with the U.S., the question of who is best equipped to navigate Canada’s economy in a new world trading order will be just as important.
The good news: The two main contenders in the election will offer differing visions. Carney’s plan will be more spending- and debt-heavy, with a focus on maintaining an assertive climate agenda. Poilievre will be less interested in climate leadership and will lean toward more free-market solutions.
We’re already starting to see this debate play out in Europe. German Chancellor-in-waiting Friedrich Merz, who leads the country’s Christian Democrats, this week reached an agreement to push through a massive spending package worth hundreds of billions of euros for defence and infrastructure. Merz’s coalition with the Social Democrats won backing for the package from the Greens by agreeing to carve out €100 billion in funding for climate goals.
