Bank of Canada can’t bail out economy if tariffs hit: economists

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Canada needs to resolve its political uncertainty as quickly as possible so it can address the challenges posed by incoming U.S. president Donald Trump, National Bank of Canada economist Warren Lovely said Wednesday.

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“Let’s get to a strong position with a clear mandate from voters in Canada to our parliamentarians,” Lovely said during an online discussion about the Bank of Canada presented by the Global Risk Institute. “To allow our federal government and our provincial governments to really enact the policies that we need to contend with today’s risk factors — Trump, of course, being chief among them.”

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On Monday, Prime Minister Justin Trudeau announced his resignation as Liberal leader and the prorogation of parliament. The move has left the country in an uncertain position, just as Trump, who has threatened 25 per cent tariffs on all Canadian and Mexican goods, prepares to take office.

Christopher Ragan, a professor at McGill University’s Max Bell School of Public Policy, told the panel that while he believes the Bank of Canada will be forced to cut rates, there is not much it can do to address the kind of shock that tariffs of that magnitude would have on the Canadian economy.

“Lower the interest rates all you want, it’s probably not going to stimulate much investment,” Ragan said.

The Bank of Canada’s policy rate currently sits at 3.25 per cent, after two consecutive half point cuts in October and December of last year. The rate now sits at the upper band of the central bank’s neutral range, with economists predicting it will have more room to fall to below two per cent, if Trump follows through on his tariff threats.

Lovely, like Ragan, thinks there is only so much the central bank could do for the Canadian economy in such a situation.

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“It’s not for Tiff Macklem and the Governing Council, to be reacting to Trump tariffs if they do come to pass,” said Lovely. “I think it’s for our elected officials, government leaders at the federal level, at the provincial level, even at the municipal level, to be making our case and trying to circumvent and limit the application of those tariffs.”

Other risk factors of concern include the underperformance of Canada’s economy in comparison to the U.S.

“Canada has been operating and running below its economic potential, opening up slack,” Lovely said. “The U.S. has been operating above potential, running above its speed limit.”

As a result, the Bank of Canada has cut more aggressively than the U.S. Federal Reserve. This divergence is expected to continue as the federal reserve has signalled a pause to its cuts in January, which will cause the Canadian dollar to fall further against the U.S. currency.

An additional risk discussed by both Lovely and Ragan, was Canada’s fiscal position. Lovely says the federal deficit has become structural and while Canada’s finances may look more sustainable in comparison to the U.S., Ottawa should hit a reset.

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“We never really want to be using the U.S. fiscal path as a as a rule of thumb that we can apply in Canada,” he said. “We really do need to hold ourselves to a to a stricter standard.”

Ragan warned spending pressures will only grow in the face of an aging demographic, which will push up costs for Old Age Security, and pressures to allocate more on Canada’s defence spending.

Longer term, these fiscal pressures will impact the Bank of Canada’s neutral rate target, pushing it higher than where it is currently predicted to land in 2025.

“What that means is we might see the Bank of Canada’s rates go down a little bit more for cyclical reasons,” said Ragan. “But I don’t think we should be surprised if the estimates of the neutral rate are rising over the next decade or so, which means that the longer-term target for the Bank of Canada, has a pretty good chance of rising, not falling.”

• Email: jgowling@nationalpost.com

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