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The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages

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  • Kimberly Beaton
  • René Lalonde
  • Stephen Snudden

Abstract

This 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.

Suggested Citation

  • Kimberly Beaton & René Lalonde & Stephen Snudden, 2010. "The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages," Staff Working Papers 10-40, Bank of Canada.
    • Handle: RePEc:bca:bocawp:10-40
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    References listed on IDEAS

    as
    1. Kimberly Beaton & Brigitte Desroches, 2011. "Financial Spillovers Across Countries: The Case of Canada and the United States," Discussion Papers 11-1, Bank of Canada.
    2. René Lalonde & Dirk Muir, 2007. "The Bank of Canada's Version of the Global Economy Model (BoC-GEM)," Technical Reports 98, Bank of Canada.
    3. Mr. Vladimir Klyuev, 2008. "Real Implications of Financial Linkages Between Canada and the United States," IMF Working Papers 2008/023, International Monetary Fund.
    4. Leonardo Gambacorta & David Marques-Ibanez, 2011. "The bank lending channel: lessons from the crisis [Financial intermediaries and monetary economics]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 26(66), pages 135-182.
    5. Ali Dib, 2010. "Banks, Credit Market Frictions, and Business Cycles," Staff Working Papers 10-24, Bank of Canada.
    6. Marc-André Gosselin & René Lalonde, 2005. "MUSE: The Bank of Canada's New Projection Model of the U.S. Economy," Technical Reports 96, Bank of Canada.
    7. Andrea Gerali & Stefano Neri & Luca Sessa & Federico M. Signoretti, 2010. "Credit and Banking in a DSGE Model of the Euro Area," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 107-141, September.
    8. Stephen Murchison & Andrew Rennison, 2006. "ToTEM: The Bank of Canada's New Quarterly Projection Model," Technical Reports 97, Bank of Canada.
    9. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 49(4), pages 517-531.
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    Cited by:

    1. Kolasa, Marcin, 2014. "Real convergence and its illusions," Economic Modelling, Elsevier, vol. 37(C), pages 79-88.
    2. Bandyopadhyay, Satiprasad & Jha, Ranjini & Kennedy, Duane, 2017. "The effect of the US subprime crisis on Canadian banks," Advances in accounting, Elsevier, vol. 36(C), pages 58-74.
    3. Snudden, Stephen, 2016. "Cyclical fiscal rules for oil-exporting countries," Economic Modelling, Elsevier, vol. 59(C), pages 473-483.
    4. Montinari, Letizia & Stracca, Livio, 2016. "Trade, finance or policies: What drives the cross-border spill-over of business cycles?," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 131-148.
    5. Fatemeh Razmi & Azali Mohamed & Lee Chin & Muzafar Shah Habibullah, 2017. "How Does Monetary Policy Affect Economic Vulnerability to Oil Price Shock as against US Economy Shock?," International Journal of Economics and Financial Issues, Econjournals, vol. 7(2), pages 544-550.
    6. Kopoin, Alexandre, 2015. "Cross-border Banking, Spillover Effects and International Business Cycles," MPRA Paper 65515, University Library of Munich, Germany, revised 06 Apr 2015.
    7. Patrick Blagrave & Claudia Godbout & Justin-Damien Guénette & René Lalonde & Nikita Perevalov, 2020. "IMPACT: The Bank of Canada’s International Model for Projecting Activity," Technical Reports 116, Bank of Canada.

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    More about this item

    Keywords

    Business fluctuations and cycles; Economic models; International topics;
    All these keywords.

    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

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