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

Building on the growing evidence on the importance of large data sets for empirical macroeconomic modeling, we use a large factor-augmented VAR (FAVAR) model 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, and evaluate the impact of each shock on key Canadian macroeconomic variables. Results 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 and global inflation is substantially lower.

► We use a large factor-augmented VAR (FAVAR) model to analyze how global developments affect the Canadian economy. ► We focus on several sources of shocks including shocks to commodity prices, foreign economic activity, and foreign interest rates. ► We evaluate the impact of each shock on key Canadian macroeconomic variables. ► Canada is primarily exposed to shocks to foreign activity and to commodity prices. ► The impact of shocks to global interest rates and global inflation is substantially lower.