How Do Import Tariffs Affect Aggregate Prices? Theory and Evidence from Canada

Christian Bustamante, Xing Guo, Lu Han, Soyoung Lee, Gaelan MacKenzie, Mariel Yacolca Maguiña and Jacob Short

Staff Working Papers from Bank of Canada

Abstract: By how much do import tariffs raise aggregate prices? We develop a simple decomposition that separates the aggregate price effect of a tariff into three channels—cost pass-through, markup adjustments, and consumer substitution across varieties—and calibrate an oligopolistic competition model with endogenous markups to firm-level market shares for Canadian domestic producers, U.S. exporters, and rest-of-world suppliers. A 25% counter-tariff on U.S. imports raises Canada's aggregate price index by 0.66—well below the 1.25% that direct cost pass-through alone would predict. The dominant offsetting force is consumer substitution toward non-U.S. varieties, which reduces the price effect by 0.47 percentage points; markup adjustments, holding fixed pre-tariff market shares, contribute a further 0.26 percentage point decrease. The gap between cost pass-through and the true price effect widens sharply with the tariff rate: at a 50% tariff, cost pass-through alone predicts more than twice the true price effect.

Keywords: Monetary policy; Inflation dynamics and pressures; Structural challenges; International trade, finance and competitiveness (search for similar items in EconPapers)
JEL-codes: E E3 E31 F F1 F13 F14 L L1 L11 L16 (search for similar items in EconPapers)
Pages: 50
Date: 2026-10
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