Note: The authors have relied on available information regarding tariff issues between the United States and Canada, based on the most recent knowledge, up to February 24, 2025.
Economic policy uncertainty arises when future policies and regulatory frameworks are unclear or unpredictable, creating risks that can negatively influence investment and spending decisions by businesses and households. The Economic Policy Uncertainty Index, developed by Baker, Bloom, and Davis (2016)1, has shown elevated levels since November 2024 for Canada, likely reflecting a series of major shocks and structural challenges affecting the Canadian economy. Our econometric analysis confirms that heightened economic and political uncertainty hinders economic activity, particularly impacting small business confidence in both the short and long term, increasing the share of firms reporting worse-than-normal unsold inventories, and discouraging plans for full-time hiring.
Following U.S. President Trump’s decision to postpone tariffs on Canadian exports to the U.S. on February 3rd, Canada has gained a brief one-month reprieve. However, this situation causes economic uncertainty, undermining business confidence and stalling investment. For entrepreneurs, uncertainty is among the biggest challenges in decision-making and long-term planning.
Over the last decade, Canada has faced successive political and economic shocks that have deepened the climate of uncertainty in the economy. From the oil price collapse in 2014 to the heightened U.S.- Canada trade tensions in 2018-2019, the COVID-19 crisis (2020-2022), and the subsequent surge in energy prices, inflation, and now renewed tariff disputes—each disruption has required swift and decisive responses from policymakers and economic actors. Domestic factors, such as the Prime Minister's decision not to run for re-election and the upcoming federal elections, shifting immigration policies, climate disasters, energy transition debates, and labour relation issues—including railway blockades and Canada Post work stoppages—further intensify uncertainty, making strategic planning increasingly challenging for businesses nationwide.
Our recent survey on the U.S.-Canada tariffs situation and its impact on Canadian small businesses underscores the growing uncertainty. When asked how long their business could survive without government support under a 25% U.S. tariff and corresponding Canadian retaliatory tariffs, more than a quarter (27%) said they could not sustain operations beyond six months. More strikingly, 42% of business owners are unsure of how long they can endure, highlighting the deep uncertainty in the Canadian economy.
Figure 1
Without government support, about three in ten businesses wouldn't last six months under U.S.-Canada tariffs, and four in ten are uncertain
Source: CFIB, Survey on the impact of U.S.-Canada tariff situation on businesses, February 6 -13.
Question: If U.S. tariffs and Canadian retaliatory tariffs are imposed at the previously suggested levels, how long can your business sustain its operations without any government support? (Select one)
“Customers are very unsure of the economic situation, causing job cancellations, higher costs, lower demand as people want to wait and see how things go before purchasing services and products.”
– ON, Manufacturing.
This concern is widespread. 71% of business owners believe the tariff situation has created exceptional uncertainty for their business, making it difficult to plan. Additionally, 56% have been forced to rethink their investment and hiring strategies, delaying expansion plans and putting recruitment efforts on hold due to the unpredictable economic climate. Finally, 45% report significant disruptions to their operations, citing increased costs, supply chain challenges, as direct consequences of the tariff’s uncertainty.
Figure 2
Uncertainty, strategic reevaluation, and operational disruptions are direct effects of U.S.-Canada tariffs on businesses
Source: CFIB, Survey on the impact of U.S.-Canada tariff situation on businesses, February 6 -13.
Question: To what extent do you agree or disagree with the following statements regarding the U.S.-Canada tariff situation? (Select one for each line)
Economic uncertainty weighs heavily on Canadian entrepreneurs. Uncertainty poses a challenge for entrepreneurs, who may either reduce or delay their investments and expansion plans. For households, it often results in a decrease in consumption. Economic decisions are typically based on expectations about future outcomes. Firms invest according to the anticipated demand and needs, while households make spending and saving choices based on expected future income and the broader economic environment. Uncertainty, by undermining the formation of clear expectations, can delay these crucial economic decisions, as individuals and businesses lack a clear picture of the future. Moreover, uncertainty increases perceived risk, which in turn raises borrowing costs for both firms and households. This can further constrain domestic demand and hinder economic activity (Christiano et al., 2014)2.
Uncertainty, though not directly observable, can be captured using proxies. A widely used measure is the Economic Policy Uncertainty (EPU) index, developed by Baker, Bloom, and Davis (2016)1. Economic policy uncertainty refers to the lack of clarity regarding current and future policies—such as monetary, tax, spending, and regulatory measures—that significantly impact the economy. Baker, Bloom, and Davis (2013)3 developed a dynamic indicator of economic policy uncertainty for the United States and later applied similar methods to other countries, including Spain, the UK, Canada, and India.
A key motivation behind this index was to examine whether policy uncertainty hinders economic recovery. When uncertainty is high, firms become more risk-averse, reducing investment, hiring, and spending—actions essential for economic growth. Baker, Bloom, and Davis (2013)3 found that rising economic policy uncertainty leads to lower investment, reduced hiring, and a decline in industrial production.
Figure 3
Both business owners' optimism indices evolve inversely to economic and political uncertainty
Sources:
- CFIB, Your Business Outlook Survey, January 2014-January 2025.
- Economic Policy Uncertainty Index, January 2014-Janurary 2025.
Over the past decade, the EPU index has captured major economic and political shocks affecting the Canadian economy. Figure 3 presents the EPU index for Canada alongside CFIB barometer’s long-term and short-term indices. Both CFIB indices, based on Your business outlook survey, are monthly indicators that measure the confidence of Canadian small businesses in their short-term (3 months) and long-term (12 months) economic prospects. A value of 50 indicates a neutral outlook, while a higher score reflects increased optimism and a lower score signals pessimism. These indices serve as key barometers of small- and medium-sized enterprises (SMEs) economic health, influencing their investment, hiring, and expansion decisions.
A clear inverse relationship emerges between the optimism indices and the EPU index: when economic policy uncertainty is low, overall business confidence remains high, whereas a rise in uncertainty leads to a marked decline in overall optimism.
The EPU index’s fluctuations reflect key disruptive events over the observed period. It reached unprecedented levels at the onset of the COVID-19 crisis before declining sharply in response to initial policy measures and vaccine rollouts. A renewed spike followed the pandemic, driven by the energy price shock and subsequent inflationary pressures.
More recently, uncertainty stemming from trade tensions with the United States appears to have had an even greater impact than the COVID-19 crisis. In January 2025, the index surged to an all-time high of 868, the highest level recorded since its inception. However, this escalation is not solely attributable to trade disputes; political uncertainty surrounding the Prime Minister’s decision to step down as leader of the Liberal Party in January 2025 has also contributed to heightened economic uncertainty.
“We are the first step in the chain of having a building constructed, and the fear and uncertainty generated by this situation has created a pause in the initiation of any new projects. This is very reminiscent of the 2009 financial crash, the facts of what's actually happening aren't as important as the uncertainty of what could happen.”
– AB, Professional services.
An econometric analysis confirms that increases in economic policy uncertainty significantly impact economic activity in Canada. Using a Vector Autoregression (VAR) model, we estimated the effects of uncertainty on key economic variables, including long- and short-term optimism indices, the share of businesses reporting worse-than-normal unsold inventories, and those planning to recruit full-time employees. Covering the period from January 2014 to January 2025, the VAR model captures dynamic relationships between variables by considering both their own past values and those of other factors. This approach, widely used in macroeconomics and policy analysis, helps forecast trends and assess economic shocks. The estimation process involves selecting relevant variables, determining the optimal lag length, estimating parameters, and evaluating model fit. VAR models are valuable for forecasting, impact analysis, and understanding how shocks propagate across an economy.
Figure 4
Impulse response functions to shocks in Economic Policy Uncertainty
Sources: EPU index (https://www.policyuncertainty.com), CFIB Monthly business barometer and authors’ calculations.
Figure 4 illustrates the responses of key economic variables to simulated shocks in the EPU index. These simulations mathematically introduce a shock to the EPU index to observe the resulting responses in other variables. Confidence intervals are determined using Monte Carlo integration and the fractile method (Sims & Zha, 1999)4. The horizontal axis represents the number of months following a positive shock, while the vertical axis measures deviations from the standardized mean.
A one-standard-deviation increase in the EPU index leads to a noticeable rise in the share of businesses reporting worse-than-normal unsold inventories. This effect is immediate, appearing in the month of the shock and persisting over the following months. By the second month, this share remains 0.1 standard deviations above the mean, suggesting a sustained impact. This prolonged effect likely stems from heightened uncertainty causing businesses to adopt a cautious stance, slowing consumption and spending, which in turn increases unsold inventory levels. Even after conditions stabilize, firms remain hesitant, reinforcing a cycle of reduced demand and excess supply.
The short-term optimism index among business owners reacts more sharply to uncertainty shocks than the long-term optimism index. Both indices deviate from the mean upon impact, but their magnitudes differ. The long-term optimism index experiences a moderate decline and gradually returns to equilibrium by the 12th month, whereas the short-term index reacts more strongly and takes nearly 24 months to stabilize. This suggests that while uncertainty affects both short- and long-term business confidence, the immediate impact is more pronounced on short-term outlooks. Economic decisions are largely expectation-driven, with businesses investing based on anticipated demand. When uncertainty clouds future prospects, entrepreneurs lose confidence in the short term, and this effect lingers until clearer signals emerge.
Similarly, the share of SMEs planning to hire for long-term positions declines in response to an uncertainty shock. This effect is prolonged, lasting up to 24 months, indicating that hiring plans are postponed due to lack of visibility on future conditions. Uncertainty forces businesses to reconsider expansion strategies, leading to cautious decision-making and delays in workforce growth.
These findings underscore the critical importance of a stable and predictable economic environment for small businesses. Ensuring clear and consistent economic policies fosters confidence, encouraging investment and growth. The current U.S.-Canada tariff dispute, even before implementation, has already introduced significant uncertainty, affecting business sentiment more than the tariffs themselves.
The exchange rate of the Canadian dollar against the US dollar and other currencies is under pressure due to the uncertainty created by the ongoing tariff dispute with the United States. As early as December 2024, when businesses were asked about the potential impact of U.S. tariffs and Canada’s retaliatory measures, their main concern was the rising cost of doing business, largely driven by the depreciation of the Canadian dollar. A weaker currency raises import costs, increasing operational expenses and squeezing profit margins for many businesses.
Figure 5
The Canadian dollar is particularly vulnerable to trade uncertainty between the U.S. and Canada
Source: Canadian Dollar to US Dollar History - CAD to USD Historical Rates
Figure 5 illustrates the Canadian dollar’s sensitivity to the uncertainty surrounding U.S. trade policies. The impact extends beyond SMEs that trade directly with the U.S., which are already feeling the immediate effects of a weaker exchange rate. Businesses that do not rely on U.S. trade are also affected, as a depreciated Canadian dollar makes it more expensive to import goods and raw materials from other countries. This leaves many businesses with difficult choices: they must either pass higher costs onto consumers by raising prices, which risks reducing demand, or absorb the extra expenses, cutting into profitability and financial sustainability.
Over time, persistent exchange rate fluctuations and higher costs could erode business confidence and investment. Small businesses often operate on tighter margins, making them particularly vulnerable. If they struggle to remain profitable, they may be forced to scale back expansion plans, reduce hiring, or even shut down. These challenges underscore the broader economic risks tied to trade uncertainty and highlight the need for strategies to support businesses in adapting to shifting market conditions.
“The weakening Canadian dollar is driving up costs, while consumer uncertainty is lowering demand for discretionary goods like ours.”
– ON, Retail
In this period of heightened uncertainty, SMEs require strong support from both provincial and federal governments. Businesses are already facing rising operational costs, and targeted measures could help mitigate tariffs impacts. When asked about the most effective support strategies, 65% of SMEs identified tax reductions as the top priority, followed by local procurement initiatives (59%), increased government purchases from Canadian businesses (55%), and the elimination of interprovincial trade barriers (50%) (Figure 6).
Figure 6
Key actions to offset U.S.-Canada tariffs include tax cuts, buy local initiatives, and removing trade barriers
Question: What types of government actions would be most helpful for your business to offset the potential impacts of the U.S.-Canada tariffs? (Select all that apply)
These measures would reduce Canada’s dependence on U.S. trade, strengthening economic resilience in the face of potential tariffs while fostering a more self-sufficient and competitive economy.
FOOT NOTES
1 Baker, S.R., N. Bloom, and S.J. Davis. (2016) “Measuring Economic Policy Uncertainty.” The Quarterly Journal of Economics, Vol. 131, No 4, pp. 1593-1636.
2 Christiano, L. J., R. Motto, and M. Rostagno. (2014) “Risk Shocks.” American Economic Review, vol. 104, no. 1, pp. 27–65.
3 Baker, Scott R. and Bloom, Nicholas and Davis, Steven J., Measuring Economic Policy Uncertainty (January 1, 2013). Chicago Booth Research Paper No. 13-02
4 Sims, C.A. and Zha, T. (1999) Error Bands for Impulse Responses. Econometrica, 67, 1113-1155.
METHODOLOGY AND DATA
CFIB's research is based on members’ views, which are collected through various controlled-access member surveys using a one-member one-vote system. CFIB produces clear, credible, and compelling analysis that supports the success of independent business in Canada.
CFIB membership has good representation across regions, sectors, and business sizes; hence the survey data offers a reasonable estimate of the distribution of economic activity across Canada.
The Canadian Economic Policy Uncertainty is an index built by Baker, S.R., N. Bloom, and S.J. Davis. similarly to their U.S. newspaper index, using five Canadian newspapers—The Gazette, The Vancouver Sun, The Toronto Star, The Ottawa Citizen, and The Globe and Mail—along with articles from the Canadian Newswire.
The index counts articles containing uncertain or uncertainty, economic or economy, and policy-related terms (policy, tax, spending, regulation, central bank, budget, and deficit), scaled by the number of articles containing today.
Each newspaper’s monthly series is normalized to a standard deviation of 1 before 2011, summed across papers, and then adjusted to a mean of 100. Monthly updates may slightly revise the past two months' data due to delayed article entries in online archives. The data is available at Economic Policy Uncertainty Index.
Your Business Outlook is a monthly CFIB tracking survey that covers small business confidence, expectations, and operating conditions. Findings are typically based on several hundred responses from a stratified random sample of CFIB members. Every last Thursday of the month, results are released in our Business Barometer® reports (Canada, provinces and industries), at cfib.ca/barometer.
CFIB Survey on the impact of the tariff situation on businesses
Sample: Based on responses from 2510 CFIB members who are owners of Canadian independent businesses, from all sectors and regions of the country. For comparison purposes, a probability samples with the same number of respondents would have a margin of error of +/-1.96%, 19 times out of 20. Purpose and Context: This survey was conducted by the Canadian Federation of Independent Business (CFIB) to gain deeper insights into businesses' experiences with the evolving U.S.-Canada trade landscape.
VAR model estimation
The VAR model includes the following monthly variables: (1) the EPU index, (2) the long-term optimism index, (3) the short-term optimism index, (4) the share of businesses planning to hire for long-term positions, and (5) the share of businesses reporting worse-than-normal unsold inventories. All variables were stationary in levels, and the system remained stable with two lags. The model also incorporates a linear deterministic trend and intercept dummy variables to account for data spikes related to the COVID-19 outbreak (2020m3, 2020m6).
For replication requests, please contact the authors to access the necessary materials.
