2025: Disruptive U.S. Policy and Economic Resilience
The U.S. and global economies proved resilient in 2025.
There were reasons, particularly around U.S. President Donald Trump’s April 1 “Liberation Day,” to fear a global trade war or corrections in financial markets that would cause a recession in the United States and a sharp slowing of the global economy.
In fact, while growth in the United States and most major economies slowed in 2025, other policy and market factors offset at least in part the early effect of disruptive policies by the U.S. administration.
The United States’s trading partners chose to avoid an all-out trade war, and most negotiated some form of accommodation with President Trump.
In North America, an exemption under the International Emergency Economic Powers Act (i.e., border security and stopping fentanyl), tariffs for goods that qualify for preferential treatment under the Canada–United States–Mexico Agreement (CUSMA) thus far have contained damage to trade.
In the United States, an extraordinary surge in AI-related investment by big tech firms mitigated the effect of the slower growth of consumer spending while bolstering equity markets and wealth accumulation.
Financial conditions were broadly accommodative globally: major central banks lowered their policy rates, and, aside from some bouts of nervousness, equity markets were buoyant and debt markets generally stable.
Looking Ahead: Slow Growth, Risks and Structural Change
In looking to 2026 and beyond, governments, businesses and financial markets face a new set of realities.
- There is reluctant acceptance globally that high U.S. import tariffs are likely to stay in place for the foreseeable future. Markets are adjusting by redirecting trade and investment flows. While this may help build new relationships for trade over the medium term, it comes with efficiency losses and costly adjustment that diminish prospects for near-term growth.
- AI is emerging as a powerful source of innovation with a potential to accelerate productivity growth through applications across the economy. The technology is nascent, and it is currently requiring massive investment in underlying infrastructure. Market exuberance over prospects of future profits has boosted equity valuations to dot-com territory. A bursting of the bubble could cause large losses of wealth and set back the real economy.
- The new commitment made by NATO members to allocate 5% of their respective GDPs to defence-related spending by 2035 entails a significant reallocation of resources in their economies. It also exacerbates fiscal challenges for governments already confronting high deficits and debt.
These new realities impose themselves while an already complex set of factors is requiring attention across all economies: the nexus between national and economic security; structural rigidities that are impeding productivity growth; demographics and immigration; energy security and climate change; affordability; and the trade-off between consumption today and investment for tomorrow.
This constellation of forces constrains prospects for growth in the short term in advanced as well as in emerging economies. In the medium to long term, it will affect economies differentially, depending on how well and how fast they adjust and seize new opportunities for growth.
The Short-Term Prospects in the United States and Canada
Both the U.S. and Canadian economies slowed down in 2025.
In the United States, there was a marked slowdown of household consumption and a fall in government consumption, which was partially offset by the exceptional growth of business investment driven by AI. Imports surged in the first quarter (Q1) to avoid tariffs and then plunged in Q2.
In Canada, household consumption and government consumption also decelerated in 2025, but the dominant source of the slowdown of the economy was a sharp drop in exports of goods that occurred in Q2. Investment in Canada fell because of tariffs and uncertainty.
The two economies are poised to regain some strength in 2026.
In our baseline scenario, on a fourth-quarter-over-fourth-quarter (Q4/Q4), basis, U.S. real GDP growth accelerates slowly, from 1.6% in 2025, to 1.7% in 2026 and 2.1% in 2027. U.S. core inflation moderates to just above 2% by the end of 2027.
Under the assumption that the Federal Reserve is attentive to both parts of its dual mandate after the replacement of Jerome Powell in May, it would cut its policy rate (upper limit) by 50 basis points in the second half of 2026 to 3.25% (upper limit) and keep it there through 2027.
In Canada, after growing only 0.6% on a Q4/Q4 basis in 2025, real GDP expands by 1.6% in 2026 and 1.5% in 2027. Household consumption makes modest, albeit slightly rising, contributions to growth. Business investment remains weak in 2026 but revives in 2027. Exports rebound modestly in 2026 as industries adapt slowly to tariffs; they gain more strength in 2027.
Canadian CPI inflation is at or near the 2% target over the planning horizon. Given modest growth and contained price pressures, we see scope for a cut in the policy interest rate in 2026, from 2.25% to 2%. The governor of the Bank of Canada has been clear that monetary policy cannot solve the structural challenges of the economy, but a small dose of stimulus would aid adjustment.
We see a slight firming up of Canadian long-term bond yields given the amount of government debt issued in markets globally and in Canada. The Canadian dollar may appreciate modestly as U.S.–Canada differentials for both economic growth and interest rates become somewhat narrower.
We judge that upside and downside risks to our outlook are roughly balanced.
Importantly, even with an acceleration of growth in 2026 as suggested in our baseline scenario, as in most other forecasts, real output in Canada remains on a lower trajectory than prior to the shock of U.S. tariffs and uncertainty.
Both the Bank of Canada in its Monetary Policy Report (1.5%) and Finance Canada in Budget 2025 (1.8%) identified a one-time loss of real GDP that may not be recovered even over the medium term.
The Medium Term: An Enterprise of Structural Adaptation …
Looking to 2026 and beyond, our governments and businesses have to develop and execute strategies to grow and succeed in a world radically different than the one that has underpinned our economic and national security for the past decades.
The diversification of our trade and investment, the realization of our potential as a responsible supplier of energy and critical minerals, the harnessing of AI for economic advantage and the bolstering of our defence capabilities together amount to a vast enterprise of structural change.
… Starting with Sound Fundamentals …
A priority is securing, to the greatest extent possible and on reasonable terms, some predictability to U.S. tariffs and to the future of CUSMA. Our economic diplomacy is correctly pursuing stronger linkages with other major economies, including China, India, and other emerging and developing economies.
At home, the structural adaptation of the Canadian economy will be a function of our success in attracting domestic and foreign capital and growing the tangible and intangible assets that will realize Canadian advantage.
The starting point is no different than in the prior decades: a sound macroeconomic environment, competitive taxation, sensible regulation, a stable and efficient financial system and other factors that enable capital to flow and to be allocated productively.
The principal force for structural adjustment in the economy is the market-driven process of “creative destruction” whereby capital and labour are reallocated over time to innovative firms at the expense of firms that fail to innovate and to adjust.
Canadian Peter Howitt earned the 2025 Nobel Prize in Economic Sciences for his work on the theory of sustained growth through creative destruction. Policy must aid, and not impede, this competitive process.
… with also Alignment on Smart Industrial Strategies
At the same time, because of distinct policy and market factors globally and in Canada, governments and the private sector have to align on strategies for key industries and technologies.
We cite four priorities:
- Realizing the value of our energy and natural resources and building the infrastructure to get our products to new markets.
- Facilitating and accelerating the adjustment of our manufacturing sector.
- Seizing opportunities from AI and technology to accelerate productivity growth and create distinct Canadian advantage.
- Building a competitive defence-industrial base to capitalize on rising defence spending by Canada and its allies.
All of these priorities will be well served by sound market fundamentals, but they also require policy leadership from governments and strong engagement from the private sector to position Canada advantageously in global competition.
In a period of structural change, smart policy may comprise public investment that is well targeted, ring-fenced and fiscally sound, with a view to catalyzing private investment. There is also a solid case for temporary measures by governments to enable an industry and its workers to adjust to an external shock. Support for workers should enhance skills, mobility and employment.
Still, lessons must be learned from past experiences of industrial policy in Canada and internationally. Where intervention is not successful, governments should quickly draw conclusions, cut their losses and move on.
Some Positive Early Steps by the Government of Canada
The government of Prime Minister Mark Carney began early in its mandate to focus with the provinces and territories on the first of the above four priorities under the theme of advancing nation-building projects.
The Government of Canada passed the Building Canada Act to streamline project approval and permitting and to coordinate financing, where necessary. It created the Major Projects Office (MPO) to act as a single window for proponents, and announced the first series of projects for review.
On November 27, in a moment marking a departure from the last 10 years of tension between Canada and Alberta on resource development, Prime Minister Carney and Premier Danielle Smith signed a Memorandum of Understanding (MOU) to advance major private sector energy investments.
These steps have been well received by the private sector. Yet, there will be critical factors of success for projects to get built:
- the economic case for the projects and the commitment of project proponents;
- policy clarity, including as regards the regulation and pricing of carbon;
- strategic and operational collaboration among governments at every step;
- the alignment of public and private decision-making processes and timelines;
- the fair and efficient management and sharing of risks;
- the consent and participation of Indigenous Peoples; and
- culture change and delivery capacity throughout the regulatory system.
There will be similar complexity, and urgency, in advancing the other three industrial strategy priorities. The government has promised forthcoming strategies on AI and a defence-industrial base. Manufacturing, in particular of vehicles, will be deserving of equal attention.
A Welcome Narrative in Budget 2025, but the Hard Work Awaits
Federal Budget 2025 posed the right diagnostic for Canada’s economy, and it signals a welcome shift of policy in favour of public and private investment to overcome the country’s structural challenges.
The narrative to spend less to invest more is persuasive, but we note that the fiscal bottom line was more discretionary spending, higher deficits and a higher debt-to-GDP ratio. The proposed fiscal anchors are unlikely to force the necessary, hard policy choices for prudence and sustainability.
In working toward the next budget, by keeping the priority objective of promoting investment, there is a strong case for the government to focus on structural policies, to review and simplify the tax and transfer system, to rationalize spending programs and to exert stronger fiscal discipline.
During this period of structural change and adaptation, growth in incomes and consumption is likely to be modest at best, and all governments have to resist the political urge to borrow in order to supplement them through broad-based tax cuts or transfers.
The Next Steps
Rightfully, there has been much attention over the past year paid to federal policy leadership in positioning Canada in its relationships with the United States and global partners, and in creating the conditions for a resurgence of investment.
There perhaps has been less attention, including in this report, to the responsibility of the provinces and territories to participate in a shift of policy priorities towards a stronger, integrated and more resilient Canadian economy.
Yet, the critical role for the adjustment of the economy to new global conditions ultimately resides with businesses, with the corporate boards and the management teams that will identify the strategic opportunities, take risks, innovate and invest in new projects, assets and markets.
In a period of shock to our economy, close collaboration and shared leadership among governments and businesses will provide the best opportunity to build momentum and to effect, over time, the structural change needed for future prosperity and resilience.
