North American trade and US monetary policy

This paper investigates how an increase in the United States Federal Fund rate affects the United States economy and how the effects are transmitted to the Canadian economy using the factor-augmented VAR (FAVAR) approach of Stock and Watson (2005) and Bernanke et al. (2005). A distinguishing feature of our model is the disaggregation of the traded goods sector where imports and exports are disaggregated into 12 and 13 industries, respectively. Extra information is provided on the domestic and international transmission mechanisms between the two countries. The factor-augmented VAR method allows impulse response functions to be generated for all the variables in the data set and so is able to provide a comprehensive description of the domestic and international transmission mechanisms between the United States and Canada.

► An increase in the US Federal Fund rate and its effects on the US and Canada ► The traded goods sector is disaggregated into exports industries and imports. ► The transmission mechanism between Canada and the US is examined. ► Impulse response functions are generated for all variables in the data set. ► Extra information is generated by a factor-augmented VAR analysis.