Tariffs raise Canadian prices by 0.66 percent, paper finds
A 25 percent retaliatory tariff on US imports raises Canada's aggregate price index by 0.66 percent, well below the 1.25 percent implied by direct pass-through. Researchers find that consumer substitution and markup compression offset nearly half of the direct price shock.
Substitution blunts the price shock
A 25 percent counter-tariff on US goods entering Canada produces an exact aggregate price increase of 0.66 percent.
While direct cost pass-through alone implies a 1.25 percent rise, firm-level adjustments and buyer substitution cut this effect in half.
Within-industry expenditure reallocation toward non-US varieties reduces aggregate prices by 0.47 percentage points.
At the same time, US exporters face stiffer competition and compress markups, deducting another 0.26 percentage points at fixed shares.
Across sectors, exact price changes range from 0.18 percent in Wholesale Trade, where US import share is 1.7 percent, to 3.31 percent in Metals and Machinery Manufacturing, where US market share reaches 27.1 percent.
Nonlinear scaling and incumbent gains
The gap between simple pass-through estimates and exact price effects widens nonlinearly with tariff size.
At a 5 percent tariff, the first-order approximation overstates the price change by only 9.0 percent.
At a 50 percent tariff, naive first-order methods predict a 1.86 percent increase against an exact rise of 0.88 percent, generating an overstatement of 110.6 percent.
In Mining and Utilities, concentrated domestic incumbents raise markups as US firms retreat, amplifying the cost shock by 12 to 21 percent.
Flawed math misleads policy
Standard trade models grossly overestimate the aggregate price impact of retaliatory tariffs by ignoring buyer substitution.
Central banks that calibrate rate policy to simple pass-through calculations risk over-tightening.
Realistic expenditure reallocation demonstrates that domestic inflation pressures remain muted.