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An Empirical Study of Credit Shock Transmission in a Small Open Economy

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  • Nathan Bedock
  • Dalibor Stevanovic

Abstract

In this paper we identify and estimate the dynamic effects of foreign (US) and national (Canadian) credit shocks in a small open economy. We use standard credit spreads as proxies to the external finance premium. Our first result suggests that the US and Canadian credit spreads contain substantial forecasting power for several measures of the Canadian real economic activity, especially during the recent financial crisis and its aftermath. Secondly, an adverse US credit shock generates a significant and persistent economic slowdown in Canada: the national external finance premium rises immediately while interest rates, credit aggregates, output, and employment indicators decline. Variance decomposition reveals that credit shocks have a sizeable effect on real activity measures, leading indicators, and credit spreads. On the other hand, the unexpected shocks in domestic credit spreads are not able to generate any signifiicant dynamic response of the real activity once we control for the US credit market conditions.

Suggested Citation

  • Nathan Bedock & Dalibor Stevanovic, 2012. "An Empirical Study of Credit Shock Transmission in a Small Open Economy," CIRANO Working Papers 2012s-16, CIRANO.
    • Handle: RePEc:cir:cirwor:2012s-16
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    2. Chinara Azizova & Bruno Feunou & James Kyeong, 2023. "Forecasting Risks to the Canadian Economic Outlook at a Daily Frequency," Discussion Papers 2023-19, Bank of Canada.
    3. Kevin Moran & Dalibor Stevanovic & Adam Kader Touré, 2022. "Macroeconomic uncertainty and the COVID‐19 pandemic: Measure and impacts on the Canadian economy," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 55(S1), pages 379-405, February.
    4. Kevin Moran & Dalibor Stevanovic & Stephane Surprenant, 2024. "Risk Scenarios and Macroeconomic Forecasts," Working Papers 24-01, Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management, revised Apr 2024.
    5. Dalibor Stevanovic & Rachidi Kotchoni & Maxime Leroux, 2017. "Forecasting economic activity in data-rich environment," CIRANO Working Papers 2017s-05, CIRANO.
    6. Maxime Leboeuf & Daniel Hyun, 2018. "Is the Excess Bond Premium a Leading Indicator of Canadian Economic Activity?," Staff Analytical Notes 2018-4, Bank of Canada.

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    More about this item

    Keywords

    Credit shock; factor-augmented VARMA; VAR; forecasting;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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