Evaluating the potential impacts of US tariffs

Evaluating the potential impacts of US tariffs

The new US administration is considering sweeping tariffs on imports. While many important elements are unknown, these measures could be highly disruptive to the Canadian and US economies.

US President Donald Trump has said his government would impose tariffs of 25% on goods from Canada and Mexico. He has also threatened tariffs on goods imported from other countries. This could lead to countermeasures by the United States’ trading partners, including retaliatory tariffs.

Tariffs are taxes on imports that increase the price consumers and businesses pay for goods and services.1 Tariffs affect spending, trade flows, government revenue, exchange rates, employment, gross domestic product (GDP) and inflation. They could substantially disrupt supply chains in Canada, the United States and elsewhere around the world.

In general, the economic impacts for a country imposing import tariffs depend critically on how easily businesses and households can find non-tariffed substitutes. When substitutes do not exist or cannot easily be produced in higher quantities due to capacity constraints, tariffs are more disruptive to the real economy and lead to higher inflation. In contrast, the effects are more muted when close substitutes are readily available.

At a minimum, a permanent tariff will cause a one-time, permanent increase in price levels. Whether tariffs lead to ongoing inflation will mostly depend on how household and business expectations for inflation respond to tariff-related price level increases. When expectations are well anchored to the inflation target, tariff-related price increases will have less of an effect on other prices and wages. The increase to consumer price index (CPI) inflation will therefore be temporary.

The ultimate scale, breadth, timing and duration of any US tariffs remain highly uncertain. It is also unclear how affected countries, including Canada, will react.

BANK OF CANADA/January 31, 2025