Front Matter Page

© 2005 International Monetary Fund

March 2005

IMF Country Report No. 05/116

Canada: Selected Issues

This Selected Issues paper for Canada was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on February 1, 2005. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Canada or the Executive Board of the IMF.

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Front Matter Page

INTERNATIONAL MONETARY FUND

CANADA

Selected Issues

Prepared by T. Bayoumi, M. Mühleisen, I. Ivaschenko, A. Justiniano, K. Krajnyák, B. Sutton and A. Swiston (all WHD), D. Botman, S. Danninger, and D. Hauner (all FAD), G. De Nicoló, R. Corker, and A. Tieman (all MFD), and R. Cardarelli (RES)

Approved by the Western Hemisphere Department

February 1, 2005

Contents

• PART I: REAL SECTOR ISSUES

• I. Factoring In Canadian Cycles

  • A. Factor Analysis

  • B. Results

  • C. Robustness Checks

  • D. Conclusions

• Tables

• I. 1. Variance Decomposition for the United States from a Factor Model with Two External and Two Domestic Factors

  • 2. Variance Decomposition for Canada from a Factor Model with Two External and Two Domestic Factors

• Figures

• I. 1. Factors and Posterior Deciles

  • 2. “Oil” Factor and Comovements in Selected Series

  • 3. “Real” Foreign Factor and Comovements in Selected Series

  • 4. “Exchange Rate” Domestic Factor and Comovements in Selected Series

  • 5. “Real” Domestic Factor and Comovements in Selected Series

• Appendix Tables

• I. 1. United States Data Sources, Description, and Transformations

  • 2. Canada Data Sources, Description, and Transformations

• References

• II. The Effects of U.S. Shocks on the Canadian Economy: Results from a Two-Country Model

  • A. Introduction and Summary

  • B. Model Description

  • C. Data and Estimation

  • D. Results

  • E. Conclusions

• Figures

• II. 1. Real Effective Exchange Rate and Current Account Balance

  • 2. Response of Canadian GDP to U.S. Shocks, with Immediate and Delayed Monetary Policy Response

  • 3. Response of Canadian CPI to U.S. Shocks, with Immediate and Delayed Monetary Policy Response

  • 4. Responses of GDP and Inflation to U.S. Policy Shocks, with Immediate and Delayed Monetary Policy Response

  • 5. Responses of GDP and Inflation to Exchange Rate Shock, with Immediate and Delayed Monetary Policy Response

  • 6. Responses of GDP and Inflation to Changes in the Pass-through Coefficient, with Immediate and Delayed Monetary Policy Response

• References

• PART II: FISCAL ISSUES

• III. Jam Today or More Jam Tomorrow? On Cutting Taxes Now Versus Later

  • A. Introduction

  • B. The Model and Calibration

  • C. Results of Cutting Transfers and Lowering Taxes Immediately or Later

  • D. Fiscal Spillovers

  • E. Conclusions

• Figures

• III. 1. Effects on Real GDP of Reducing Transfers and Cutting Wage Tax Immediately and with a Delay

  • 2. Effects on Real GDP of Reducing Transfers and Cutting Corporate Income Taxes Immediately and with a Delay

  • 3. Effects of Alternative Parameterizations on Impact of a Cut in Transfers and in the Wage Tax Rate on Real GDP

  • 4. Effects of Alternative Parameterizations on Impact of a Cut in Transfers and in the Corporate Income Tax Rate on Real GDP

  • 5. Impact of Tax Spillovers from the Rest of the World

• References

• IV. How Do Canadian Budget Forecasts Compare with Those of Other Industrial Countries

  • A. Introduction and Summary

  • B. The Institutional Environment for Budget Forecasts

  • C. Fiscal Forecasting Practices in International Comparison

  • D. Assessing Forecast Accuracy

  • E. Statistical Analysis of Forecast Outcomes

  • F. Conclusion

• Boxes

• IV. 1. Equalization Transfers in Canada

  • 2. Fiscal Forecasting Arrangements in Canada

  • 3. Forecasting, Performance, and Budget Debate in New Zealand

• Tables

• IV. 1. Indicators of Relations Between Legislature and Executive

  • 2. Share of Spending by Sub-National Governments

  • 3. Consolidated Central Government Expenditure Shares, 2003

  • 4. Fiscal Policy Rules and Transparency Laws

  • 5. Key Institutional Characteristics of the Fiscal Forecasting Process

  • 6. Fiscal Forecasting: Quality Assurance

  • 7. Descriptive Statistics of One-Year Budget Forecast Errors, 1995–2003

  • 8. Results of Forecast Error Median and Mean Tests

  • 9. Results of Efficiency Tests

  • 10. Comparing Budget and Consensus Forecasts

  • 11. Potential Factors Affecting Forecast

  • 12. Volatility of Macroeconomic and Fiscal Variables, 1990–2003

  • 13. Bivariate Regressions of Error Characteristics on Structural and Volatility Indicators

• Figures

• IV. 1. Influence of Sub-National Governments

  • 2. Forecast Errors: Real GDP Growth

  • 3. Forecast Errors: Fiscal Balance

  • 4. Descriptive Statistics for One- and Two-Year Macroeconomic Budget Forecast, 1995–2003

  • 5. Descriptive Statistics for One- and Two-Year Fiscal Budget Forecasts, 1995–2003

  • 6. Decomposition of Mean Forecast Errors

  • 7. Budget and Consensus One-Year Growth Forecast Errors

  • 8. Canada: Fiscal Balance Forecast Errors

  • 9. Impact of GDP Volatility on Forecast Quality

• Appendices

• IV. 1. Data Overview

  • 2. Methodological Details

• References

• PART III: STRUCTURAL ISSUES

• V. How Flexible is the Canadian Economy? An International Comparison

  • A. Introduction

  • B. Industry Data

  • C. Firm-Level Data

  • D. Macroeconomic Data

  • E. Conclusions

• Boxes

• V. 1. Indexes of Structural Changes

• Tables

• V. 1. Indexes of Structural Change

  • 2. Median-Unbiased Estimates of First Order Autoregressive Coefficient, Real Value Added

  • 3. Standard Error of First Order Autoregressive Coefficient, Real Value Added

  • 4. Phillips Curve Estimates

• Figures

• V. 1. Sectoral Change Across Countries

  • 2. Turnover Rates in OECD Countries

• References

• PART IV: FINANCIAL SECTOR ISSUES

• VI. Large Banking Groups and Financial System Soundness

  • A. Overview

  • B. Banking Sector Trends

  • C. Market-Based Financial Soundness Indicators

  • D. Soundness Indicators in Canada and the United States

  • E. Summary

• Boxes

• VI. 1. Changes to Canada’s Financial Sector Legislation

• Tables

• VI. 1. Balance Sheet Items of Six Large Banking Groups

  • 2. Vulnerability Indicators of the Banking System

• Figures

• VI. 1. Growth of Income Components of LBGs

  • 2. Average Distance to Default of LBGs

  • 3. Risk Concentration in LBGs

  • 4. Standard Deviation of Distance to Default of LBGs

  • 5. System DD Minus Average DD of LBGs

  • 6. Correlation Between Banking and Insurance Sector DDs

  • 7. Correlation Between Banking and Nonfinancial Sector DDs

  • 8. Average DD in Canada and the United States

  • 9. Risk Concentration in Canada and the United States

• References

• VII. Competition in Canada’s Banking System

  • A. Introduction

  • B. Optimal Level of Bank Competition: A Review of the Literature

  • C. Methodology and Data

  • D. Results

  • E. Conclusions

• Tables

• VII. 1. Size and Profitability Indicators of 25 Largest Banks

  • 2. H-Statistics, by Country and Region

  • 3. H-Statistics for 25 Largest Banks, by Country and Region

  • 4. H-Statistics for Largest Banks, by Country and Region

  • 5. Size and Concentration of Banking Systems Across Regions, 2003

• References