The impact of the global business cycle on small open economies: A FAVAR approach for Canada

Abstract

Building on the growing evidence on the importance of large data sets for empirical macroeconomic modeling, we use a factor-augmented VAR (FAVAR) model with more than 260 series for 20 OECD countries to analyze how global developments affect the Canadian economy. We focus on several sources of shocks, including commodity prices, foreign economic activity, and foreign interest rates. We evaluate the impact of each shock on key Canadian macroeconomic variables to provide a comprehensive picture of the effect of international shocks on the Canadian economy. Our findings indicate that Canada is primarily exposed to shocks to foreign activity and to commodity prices. In contrast, the impact of shocks to global interest rates or global inflation is substantially lower. Our findings also expose the different channels through which higher commodity prices impact the Canadian economy: Canada benefits from higher commodity prices through a positive terms of trade shock, but at the same time, higher commodity prices tend to lower global economic activity, hurting demand for Canadian exports.

Labour Adjustment Implications of Service Offshoring: Evidence from Canada

“…In other words, for any theoretical channel linking growth in business service offshoring and employment to be fruitfully observed, the economy must be meaningfully (but not wholly) dependent on its export–import sector. This is true of Canada, which is often described as ‘a textbook example of a small open economy’ (Vasishtha and Maier 2011). On this basis, we feel that Canada is well placed to capture any potential employment effects from this new wave of business service offshoring.…”

“…Moreover, the macroeconomic outlook for small open economies, in particular, can be strongly influenced by international developments such as integrated IT and the growth of costless international communication. Canada is again a case in point: ‘The Canadian economy’ in the words of a recent Bank of Canada research report, ‘has become much more integrated with the rest of the world during the last decades, as international trade has expanded and financial integration with the rest of the world has deepened’ (Vasishtha and Maier 2011). There is also evidence in Canada ‘that existing [trade] links .…”

Macroeconomic impacts on commodity prices: China vs. the United States

“…Accordingly, in this study, we use FAVAR models proposed by Bernanke et al (2005). This model has already been widely used to investigate the impacts of macroeconomic impacts (Mönch 2008, Ludvigson and Ng 2009, Zagaglia 2010, Chevallier 2011, Lombardi et al 2012, Byrne et al 2013, Vasishtha and Maier 2013.…”

How Do the Trans‐Pacific Economies Affect the USA? An Industrial Sector Approach

“…First, we can incorporate a broader set of information related to the unknown transmission mechanism by utilising detailed sectoral data. Vasishtha and Maier () claim that this aspect of FAVAR is particularly relevant when the business cycle transmission involves more than two countries. Second, the FAVAR analysis allows us to study the transmission of shocks in several dimensions, that is the effect of overall and sectoral shocks in the Trans‐Pacific on the US economy for both overall and sectors.…”

“… For studies that examine the effect on other countries, see Mumtaz and Surico (), Vasishtha and Maier (), Liu et al. (). …”