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Financial Frictions, Financial Shocks and Labour Market Fluctuations in Canada


  • Yahong Zhang


What are the effects of financial market imperfections on unemployment and vacancies in Canada? The author estimates the model of Zhang (2011) – a standard monetary dynamic stochastic general-equilibrium model augmented with explicit financial and labour market frictions – with Canadian data for the period 1984Q2–2010Q4, and uses it to examine the importance of financial shocks on labour market fluctuations in Canada. She finds that the estimated value of the elasticity of external finance, the key parameter capturing financial frictions, is much higher than the value suggested in the literature. This gives rise to a larger amplification effect from the financial accelerator mechanism, which helps the model generate a more volatile labour market. The author finds that the model accounts well for the cyclical behaviour of unemployment and vacancies observed in the data. She also finds that financial shocks are one of the main sources of fluctuations in the Canadian labour market. Overall, financial shocks contribute about 30 per cent of the fluctuations in unemployment and vacancies for the Canadian economy.

Suggested Citation

  • Yahong Zhang, 2011. "Financial Frictions, Financial Shocks and Labour Market Fluctuations in Canada," Discussion Papers 11-10, Bank of Canada.
  • Handle: RePEc:bca:bocadp:11-10

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    References listed on IDEAS

    1. Virginia Queijo von Heideken, 2009. "How Important are Financial Frictions in the United States and the Euro Area?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(3), pages 567-596, September.
    2. Christiano, Lawrence J. & Trabandt, Mathias & Walentin, Karl, 2011. "Introducing financial frictions and unemployment into a small open economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 1999-2041.
    3. Francisco Covas & Yahong Zhang, 2010. "Price-level versus inflation targeting with financial market imperfections," Canadian Journal of Economics, Canadian Economics Association, vol. 43(4), pages 1302-1332, November.
    4. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 269-300, November.
    5. Ian Christensen & Ali Dib, 2008. "The Financial Accelerator in an Estimated New Keynesian Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(1), pages 155-178, January.
    6. Yahong Zhang, 2011. "Financial Factors and Labour Market Fluctuations," Staff Working Papers 11-12, Bank of Canada.
    7. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-132, March.
    8. Ali Dib & Caterina Mendicino & Yahong Zhang, 2008. "Price Level Targeting in a Small Open Economy with Financial Frictions: Welfare Analysis," Staff Working Papers 08-40, Bank of Canada.
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    Cited by:

    1. Dib, Ali & Mendicino, Caterina & Zhang, Yahong, 2013. "Price-level targeting rules and financial shocks: The case of Canada," Economic Modelling, Elsevier, vol. 30(C), pages 941-953.
    2. Yahong Zhang, 2013. "Unemployment Fluctuations in a Small Open-Economy Model with Segmented Labour Markets: The Case of Canada," Staff Working Papers 13-40, Bank of Canada.

    More about this item


    Economic models; Financial markets; Labour markets;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • J6 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers

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