U.S. Financial Stress and Canadian Economic Activity

This paper will test for threshold effects from stresses in U.S. financial markets upon Canadian economic activity.  Using the methodology of Andrews (Econometrica 1993), which tests for the existence of threshold effects when the break point is not known a priori, we utilize the financial stress index developed by the IMF(Global Financial Stability Report, 2009) as the measure of stress in U.S. financial markets.  This stress index becomes the threshold variable in the econometric specifications.  The dependent variable will be Canadian Real GDP, or alternative industry specific output measures.  The explanatory variables will include U.S. Real GDP or an alternative U.S. output measure, a Canadian commodity price index, and the financial stress index itself.   The test procedure will identify the level of U.S. financial stress, if any, beyond which additional stresses having a negative impact upon Canadian economic activity.  By examining industry specific Canadian output measures we will be able to compare differing levels of sensitivity across Canadian industries to U.S. financial shocks.  Observed differences across industries will be compared against differences across these industries in their degree of integration with the U.S.