Bank of Canada counts the costs of the biggest threat to our economy right now
The Bank of Canada has begun to count the potential costs of escalating trade wars on the nation’s economy in a series of analyses released Wednesday as part of a rate decision in which tensions featured prominently.
Here are how their scenarios play out:
The trade war is already creating an $18 billion crater in the Canadian economy, according to the central bank.
The fallout from higher tariffs between the U.S. and China prompted the Bank of Canada to increase its estimate for how much the enduring clash over cross-border commerce is weighing on domestic and global exports as well as business investment relative to April.
These negative effects, plus China’s import restrictions on Canadian canola and meat, more than offset the positive impact from the withdrawal of American tariffs on steel and aluminum and optimism surrounding the passage of the renegotiated North American free trade agreement.
This uncertainty means Canadian exports will be 1.5 per cent lower by the end of 2021 than would otherwise be the case, and capital spending will be curbed by 3 per cent over the same time frame, the bank said.
The quarterly Monetary Policy Report also mapped out estimates for how much better or worse the picture could get as the situation evolves.
Trade conflict remains the top risk to the central bank’s outlook. Although it’s a two-sided concern, the potential effects are asymmetric — and Canada is twice as exposed to the swings as the world at large.
If all protectionist measures were rolled back and the uncertainty surrounding the multilateral trading order disappeared, global activity would be roughly 1 per cent higher by the end of 2021 relative to current forecasts, and the Canadian economy would be about 2 per cent larger.
Yet in an all-out trade war in which every country in the world were to impose 25 per cent levies on imported goods, the Canadian economy would be 6 per cent smaller relative to the base case, with the global economy taking a 3 per cent hit. The simulation suggests commodity prices would fall by 30 per cent while the Canadian dollar depreciates by 25 per cent.
Protectionism is difficult for monetary policy to respond to, policy makers said, as the negative supply shock entails higher prices but lower activity.
A staff analytical note released alongside the MPR on Wednesday shows how the U.S. is more insulated from the harshest trade war scenarios than its neighbours. If every country in the world were to impose 25 per cent levies on imported goods, the U.S. economy would take a long-run hit of 1.1 per cent, compared to 3.1 per cent for Canada and 2.8 per cent for Mexico.
These results are “consistent with what the literature has found as gains from trade for this relatively closed nation,” Bank of Canada economist Karyne Charbonneau said in the analysis. “It contrasts with the magnitude for small open economies such as Canada and Mexico.”
The conclusion also bears some resemblance to sentiments espoused by President Donald Trump, who has pointed to American deficits as a sign that the nation’s trading partners have a greater reliance on the U.S. than vice versa.
Short-run impacts could be very different, Charbonneau warns, as supply chain reorientation would likely displace workers in affected sectors. The analysis also omits certain channels, such as changes to productivity, that could influence the outcome.
Perversely, a separate simulation shows Canada and Mexico could stand to benefit from a U.S.-led trade war against the world that it excludes its continental counterparts.
These “bystanders” would see “their exports become relatively more attractive as they substitute for American goods on the world markets,” Charbonneau writes, which both enjoying modest increases in estimated long-run activity.