The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages
AbstractThis paper examines the transmission of U.S. real and financial shocks to Canada and, in particular, the role of financial frictions in affecting the transmission of these shocks. These questions are addressed within the Bank of Canada's Global Economy Model (de Resende et al. forthcoming), a dynamic stochastic general-equilibrium model with an active banking sector and a detailed role for financial frictions. We find that U.S. financial shocks, as well as real shocks, have important effects on the Canadian economy. Moreover, financial frictions on both the demand and supply sides of credit amplify the first round impact of all types of U.S. shocks on the U.S. economy, as well as the second round impact on Canada. Real-financial linkages also increase the persistence of the Canadian response to U.S. shocks. We find that the interaction between the endogenous response of commodity prices and U.S. financial frictions plays an important role in the propagation of U.S. shocks to the Canadian economy. Finally, real-financial linkages also help to generate the positive cross correlation between domestic demand in the United States and Canada observed in the data, which is difficult to explain with a model where the transmission of shocks between countries is only based only on trade.
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 10-40.
Length: 38 pages
Date of creation: 2010
Date of revision:
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Business fluctuations and cycles; Economic models; International topics;
Find related papers by JEL classification:
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
- F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-01-03 (All new papers)
- NEP-BEC-2011-01-03 (Business Economics)
- NEP-CBA-2011-01-03 (Central Banking)
- NEP-DGE-2011-01-03 (Dynamic General Equilibrium)
- NEP-MAC-2011-01-03 (Macroeconomics)
- NEP-OPM-2011-01-03 (Open Economy Macroeconomic)
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