Economic Outlook: Building Resilience and Capacity in a Disrupted World

A World Disrupted by U.S. Policy Shifts and Uncertainty

In a period of only months, actions by the U.S. administration of President Donald Trump have disrupted U.S. trade, foreign and economic policies, and created exceptional uncertainty for the U.S. and global economies and financial markets.

Questions about the strategy and end game of the President for the rules that govern international trade and investment are forcing governments, businesses and investors worldwide to reassess their own strategies and relationships.

A “tough on China” policy was largely expected, but statements and actions by the President drawing into question the foundational terms of relationships with even the strongest U.S. allies have caused intense global unease.

Much of the attention has focused on the sequence of decisions of the president on U.S. import tariffs. Despite many pauses or rollbacks of tariffs shortly after their announcement, the effective U.S. import tariff rate, at over 15%, is higher than at any time since 1934.

The threat of new and higher tariffs is ever-present, and the goals of the President in negotiations with global trading partners are not apparent.

A recent court decision declaring invalid tariffs imposed under the International Emergency Economic Powers Act (IEEPA) (including the tariffs on Canada, Mexico and China, as well as the “reciprocal” tariffs on other partners) has been stayed pending appeal by the administration.

Thus, tariff and trade uncertainty prevails.

Yet, the uncertain prospects for the U.S. economy and the risks to financial stability posed by large U.S. fiscal deficits and debt, such as permitted by the “big, beautiful bill” in Congress, are at least just as worrisome.

At their meeting of May 22 in Kananaskis, G7 finance ministers and central bank governors recognized that “elevated uncertainty can have implications for the economy and for financial stability.”¹

High Stakes for Canada in Seeking a New Relationship with the United States

Given the scope and depth of Canada’s relationship with the United States and our status as a middle power, the policy disruptions in the United States and the fallout for the global economy pose an existential threat.

Prime Minister Mark Carney has stated that the old relationship between Canada and the United States based on steadily increasing integration is over. However, there is no economic and national security for Canada without a constructive partnership with the United States.

Adjustment to U.S. tariffs on imports from Canada and Mexico since their original announcement have mitigated impacts for our economy, but tariffs on steel and aluminum products and automotive vehicles and parts are inflicting damage on key industries and regions.

Moreover, the heightened uncertainty is a strong deterrent to investment and spending and thus acts as a drag on the economy.

Prime Minister Carney and President Trump have begun a dialogue. For Canada, the priority is predictability if not certainty on tariffs and the future of the Canada–United States–Mexico Agreement (CUSMA) within the frame of a new relationship to advance the shared interests of both countries.

While the president suggests that the United States does not need Canada, in fact there is much that we bring to the relationship, and all of our assets can be leveraged to secure agreement. Our position in the negotiations is reinforced by a Team Canada approach uniting governments and businesses.

Until We Find a Resolution: A Wide Range of Scenarios for the U.S., Global and Canadian Economies

Given this backdrop, there is a wide range of plausible scenarios for growth, inflation and interest rates in the U.S. and Canadian economies in the second half of 2025 and in 2026 and 2027.

We have constructed a baseline scenario by assuming that by the end of 2025 the United States will conclude trade agreements with its major economic partners, including Canada. The agreements will reduce uncertainty and lessen, but not eliminate all, U.S. import tariffs.

Under our baseline scenario, the U.S. economy slows down in the second half of 2025, but it does not undergo a recession. The economy picks up momentum in 2026 and 2027.

• On a fourth-quarter-to-fourth-quarter (Q4/Q4) basis, real gross domestic product (GDP) growth falls from 2.5% during 2024 to 1.1% during 2025, before rising to 1.7% during 2026 and 2.2% during 2027.
• U.S. core personal consumption expenditure (PCE) inflation peaks at about 3.5% before the end of 2025, and then declines progressively to around 2% by the end of 2027.
• With the slowing of the economy and with greater clarity on inflation trends, the Federal Reserve cuts its policy rate by 25 basis points once by the end of 2025, and three more times by July 2026, bringing the Fed funds rate (upper limit) to 3.5%.
• Despite the reduction in inflation and the cuts in the policy rate, the 10-year U.S. treasury yield stays at roughly the current level of 4.5% over the planning horizon as markets remain sensitive to the size and growth of the U.S. public debt.

The growth profile is roughly similar for Canada under our baseline scenario, but we expect a technical recession in the middle quarters of 2025.

• On a Q4-to-Q4 basis, growth would fall sharply from 2.3% in 2024 to 0.3% in 2025, before rising to 1.8% in 2026 and 2% in 2027.
• Headline Consumer Price Index (CPI) inflation remains at or very close to the Bank of Canada’s (BoC) 2% target.
• The BoC lowers its policy rate from 2.75% in June 2025 to 2.25% by December 2025. Given assumptions in our baseline scenario, we project the policy rate to hold at 2.25% in 2026 and 2027.
• 10-year Government of Canada (GoC) bond yields, at about 3.2%, maintain a differential of some 130 basis points relative to the yield on U.S. treasuries.

The risks are mostly to the downside. Growth in Canada will be lower, and a recession more severe, if the United States maintains or even ratchets up its tariffs, if no trade agreement is concluded and uncertainty prevails, or if there is an escalation of a trade war between the United States and China.

A quick resolution of trade tensions that would bolster global trade and activity is an upside risk, but one to which we ascribe a low probability.

Building Resilience: The Diversification of Our Markets

Beyond tariffs and short-term uncertainty, Canada today confronts long-standing economic policy gaps and structural weaknesses. In front of what he describes as the biggest crisis in our lifetime, Prime Minister Mark Carney has proposed an ambitious transformation of the economy.

To enhance our sovereignty and economic resilience, there is a widely recognized need to reduce our dependence on the United States over time by realizing a more integrated domestic economy and by expanding our linkages with the countries of the Asia Pacific Region and Europe in particular.

There is wide agreement that a place to start is free trade in Canada. Pronouncements and steps by premiers in the last weeks and months in favour of the mutual recognition of standards and labour mobility represent meaningful progress. Strong leadership and diligent follow-through will be required to maintain the momentum and to overcome the multiple obstacles that still stand in the way.

New markets for our exports and more diversified supply chains will never be a substitute for what will continue to be our paramount economic relationship with the United State. Our goal should be less to divert trade from the United States than to grow our other markets faster. This rests not so much on the government signing new trade deals as it does on businesses enhancing their market development.

Building Capacity: The Expansion of Investment

In successive Economic Outlooks, we have insisted that prosperity and national security for Canada depends on bolstering investment in productive capacity and innovation.

Currently, there is an opportunity and a need to unlock investment in at least five domains: trade corridors, energy and critical minerals, defence and security, housing, and innovation and productivity-enhancing technology. In each case, the ambition is high. The challenge is execution.

Trade Corridors

First ministers are developing a list of projects in the national interest in consultation with Indigenous Peoples. The immediate task is to move from concepts of trade corridors to actual projects led by committed proponents.

In turn, a condition to attract and mobilize the capital for investment is collaboration among governments to streamline project review and permitting. The GoC plans to table One Canadian Economy legislation for this purpose. The first ministers are pledging to address project approval, permitting efficiency and timelines for all projects.

The early participation of Indigenous peoples is now widely recognized as an opportunity to move projects forward while advancing reconciliation and sharing economic benefits. There are many successful examples. An outstanding challenge is proceeding with both legal clarity and speed.

Energy and Critical Minerals

Canada is well positioned to leverage a rich energy and resource base as a competitive asset for the domestic economy and to play a growing role with allies in responsible and reliable supply chains.

For oil and gas (including liquefied natural gas [LNG]), the critical issue for governments and industry is finding a path to realize the value of our resources while driving down the intensity and ultimately the absolute amount of greenhouse gas (GHG) emissions in the production process.

Public and private investment to power a clean economy also requires clarity of environmental and economic regulation such that each jurisdiction may advance a supply mix, including baseload and intermittent energy, that makes the best use of its resources and capabilities.

Defence and Security

To meet our commitments to our allies and to safeguard our national security, Canada must grow defence spending from 1.4% of GDP in 2024 to at least 2% of GDP by 2030 or earlier; in fact, discussion in NATO will push our spending target higher.

A critical responsibility is ensuring that to the greatest extent possible this expenditure draws upon, and reinforces, the country’s economic capabilities, assets and technologies.

A stronger domestic defence industrial base and strategic linkages with partners in Europe and the Asia Pacific Region can contribute to enhanced security, the diversification of our trade and stronger growth.

The protection of our territorial sovereignty can also be advanced by investment in dual-use infrastructure in Canada’s North, also supporting resource development, opening new trade routes and creating opportunity for Indigenous communities.

Housing

Real house prices have nearly doubled in the country since 2007. There is a shortage of supply, including a lack of rental and affordable housing.

The GoC has set a goal to double the rate of annual home construction to 500,000. It has proposed the creation of a new housing industry that draws on modular and prefabricated housing technology, Canadian workers and Canadian lumber.

While the direction is the right one, the ambition may be tempered by the fact that Canada already allocates greater resources to resi1dential investment than any other advanced economy. Supply constraints, including those on the availability of workers, will be manifest if there is also an acceleration of large projects.

Leadership by provincial and municipal officials is essential to speed up permitting and infrastructure development and to achieve steady, measurable progress in the building of homes.

Technology and AI

A national effort to build physical infrastructure and assets cannot obscure the need to innovate and to lift productivity growth across the economy, notably through technology, digitalization and artificial intelligence (AI).

Similarly, our preoccupation with trade in goods in response to U.S. tariff action ought not overshadow the services sectors (including the public sector) and the value of investment in intangible assets, including intellectual property and data, for our economic and national security.

In fact, the continued expansion of U.S. big tech and the rapid emergence of China as an innovation powerhouse across a range of strategic technologies pose at least as existential, if not as immediate, a challenge to our sovereignty and prosperity as the Trump tariffs.

The Lynchpin: The Attraction and Mobilization of Private Capital

Canada is not alone in the pursuit of enhanced economic and national security, and it is competing with other jurisdictions to attract and execute investment that will be led and financed in large majority by the private sector.

The Prime Minister has stated unequivocally that Canada is not for sale. However, Canada is open for business, and this must be conveyed not only by the federal government but by provinces, territories and Indigenous and business leaders.

The larger share of the investment will be driven and financed by the private sector. Structural policy—in large measure, sound and efficient regulation—must be the principal instrument to support private investment and risk-taking.

Given fiscal constraints, governments have to make judicious use of their resources and balance sheets. A political determination to build and to unlock investment can attract many proposals that have an uncertain business case and that seek large public subsidies. Governments have to be principled, consistent, disciplined and coordinated in responding to such proposals.

A Core Responsibility Even More Acute in an Uncertain World: Sustainable Public Finances

Governments worldwide are confronting a range of fiscal pressures in a period of global disruption, low economic growth and political tensions. In 2024, general government gross debt exceeded US$100 trillion, or 92% of global GDP. It was 64% before the Global Financial Crisis (GFC) in 2007–2009.

Meanwhile, the cost of public debt has risen. After a 30-year period of declining bond yields to nearly zero just before COVID in 2020, governments are now paying a higher price when refinancing maturing debt or issuing new bonds. For Canada, the 10-year bond rate is 3.2%.

Given a rising debt as a proportion of GDP, and higher interest costs, governments, including governments in Canada, are allocating a greater share of their revenue to debt service.

Recent increases in U.S. treasury yields and a downgrade of the United States as sovereign borrower by Moody’s have served as reminders of the exposure of governments to the market’s judgment of risk.

Canada fares well in some international fiscal comparisons. Its net general government debt—that is, public debt minus financial and non-financial assets—as a proportion of GDP is among the lowest in advanced economies.

However, on a gross basis, Canada’s public debt ratio is at par with the average of advanced economies. Thus, Canada’s exposure to the debt markets—our annual borrowings to refinance our public debt and fund our deficits—is proportionately comparable to that of our peers.

In a highly uncertain world, governments must consider carefully the sustainability of public finances. If there is not strict fiscal discipline, debt dynamics can quickly become unfavourable. Debt can then rise faster than GDP, interest costs can absorb a rising proportion of revenue, and access to new borrowing can become more difficult and more expensive.

The GoC has decided not to table a fiscal update or budget this spring.

The federal minister of finance will face a long list of fiscal pressures over the next months and years. Foremost among them will be raising defence spending to well over 1.76% of GDP by 2030, the level of spending built into the last budget.

The Speech from the Throne pledged that the government will spend less so that Canadians can invest more. To exert fiscal discipline, the government plans to reduce the growth of operating expenditures to below 2% per year by capping the size of the public service, ending duplication and deploying technology, including AI, to improve public sector productivity.

Such steps will be helpful. However, they will not be sufficient to achieve what is widely regarded as an indicator of fiscal sustainability over the medium term, namely, a declining federal debt-to-GDP ratio.

The government has excluded cuts in major transfers to provinces, territories or individuals. To bring the debt ratio down over time, we judge that there will need to be material cuts to federal program spending.

Under prudent assumptions, we estimate that bringing the federal debt-to-GDP ratio down steadily will require permanent savings of some 15% to 20% in non-defence program spending over the fiscal planning horizon, or C$30 billion to C$45 billion per year on an ongoing basis.

This is a significant undertaking, yet one much less drastic than the fiscal adjustment of the mid-1990s.

A review of federal programs to eliminate those that are not mission critical or effective would allow ministers and a streamlined public service to focus on core federal responsibilities and on the efficient delivery of a limited set of priorities.

Importantly, a sustainable fiscal plan can include larger borrowing to fund government investments in financial or non-financial assets if they deliver concrete benefits and future revenue streams. This can be helpful in some cases to lever or “crowd in” large amounts of private capital.

To make the best use of the public balance sheet and to promote the efficient management of large infrastructure assets, the federal as well as provincial governments should give greater consideration to pricing roads and bridges, among other projects. This could shift more costs from taxpayers to users and create an opportunity for the expanded use of public–private  partnerships.

To free up capital for public investment in new assets, governments should also consider the sale or long-term lease of existing assets, such as major airport terminals, that generate a steady stream of income and that can represent sound, long-term business propositions for institutional investors.