An Empirical Study of Credit Shock Transmission in a Small Open Economy
AbstractIn this paper we identify and measure the effects of credit shocks in a small open economy. To incorporate information from a large number of economic and financial indicators we use the structural factor-augmented VARMA model. In the theoretical framework of the financial accelerator, we approximate the external finance premium with credit spreads. We find that an adverse global credit shock generates a significant and persistent economic slowdown in Canada; the Canadian external finance premium rises immediately while interest rates and credit measures decline. Variance decomposition reveals that the credit shock has an important effect on real activity measures, including price and leading indicators, and credit spreads. On the other hand, an unexpected increase in the Canadian external finance premium shows no significant effect in Canada, suggesting that the effects of credit shocks in Canada are essentially caused by the unexpected changes in foreign credit market conditions. Given the identification procedure our structural factors have an economic interpretation.
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Bibliographic InfoPaper provided by CIRANO in its series CIRANO Working Papers with number 2012s-16.
Date of creation: 01 Jun 2012
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Credit shock; structural factor analysis; factor-augmented VARMA;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-01 (All new papers)
- NEP-CBA-2012-07-01 (Central Banking)
- NEP-MAC-2012-07-01 (Macroeconomics)
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