Real Implications of Financial Linkages:The Case of Canada and the United States

Vladimir Klyuev ()

No 1199, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: This paper investigates the impact of changes in U.S. financial conditions on financial conditions and real economic activity in Canada. It shows that close to a quarter of financing by Canadian corporations is raised south of the border. Empirical analysis using structural vector autoregression establishes that a tightening in U.S. financial conditions has significant implications for real activity in Canada. For example, a one percentage point increase in the 3-month T-bill rate leads to a decline of slightly more than one percentage point in Canada’s real GDP growth after 3 quarters. That decline can be decomposed into three channels: the direct financial channel, where the slowdown is attributed to a rising cost of funds for Canadian companies raising capital in the United States; the indirect financial channel, where growth is hampered as financial conditions in Canada tighten in response to a tightening in the United States; and the trade channel, which goes through a slowing in the U.S. economy, and correspondently lower demand for Canadian exports. The direct financial channel appears dominant in the short term.

Date: 2010
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