This paper assesses the impact of high household debt on economic volatility in Canada. The debt per se may not necessarily be a risk for economic activity; it can amplify other shocks as well. A few studies have emphasized the link between the growth of household debt before 2007 and the severity of the Great Recession. Economies with debt tend to experience more severe housing busts and recessions. If household debt ratios are not stabilized, the vulnerability of the Canadian economy is likely to be high.

Abstract

This paper assesses the impact of high household debt on economic volatility in Canada. The debt per se may not necessarily be a risk for economic activity; it can amplify other shocks as well. A few studies have emphasized the link between the growth of household debt before 2007 and the severity of the Great Recession. Economies with debt tend to experience more severe housing busts and recessions. If household debt ratios are not stabilized, the vulnerability of the Canadian economy is likely to be high.

IV. Canada’s Loss of External Competitiveness: The Role of Commodity Prices and the Emergence of China1

A. Introduction

1. Canadian merchandise exports have been on a roller coast over the last two decades, surging to 40 percent by end-2000 and falling to 24 percent of GDP in 2010. Importantly, the composition of exports changed significantly as not all sectors were affected equally. The rise in exports in the 1990s was widespread, but the expansion in manufacturing was particularly impressive. After 2000, the fall in exports as a share of GDP was predominantly concentrated in manufacturing, while energy exports continued to expand and now represent about one fourth of all merchandise exports. While exporters benefited from a depreciation of the Canadian real effective exchange rate (REER) in the 1990s, commodity prices surged in the 2000s and were accompanied by a large appreciation of the REER. Higher commodity prices may well have an overall positive effect on the Canadian economy (see Carney, 2012).2 But by driving the real exchange rate up, they may have also contributed to Canada’s loss of external competitiveness and faster decline of its manufacturing share of value added over the last decade (chart). In this chapter, we focus on the factors behind Canada’s loss of external competitiveness, and in particular we try to assess the role played by higher commodity prices and the emergence of China as a major trade power.

uA04fig01

Manufacturing Share in the Economy

(Manufacturing value added as share of GDP)

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Sources: United Nations National Accounts.

2. In recent years there has been a renewed interest in studying the links between commodity prices, the exchange rate, and manufacturing production in Canada. Beine et al. (2009) estimate that about 40 percent of the manufacturing employment loss in Canada between 2002 and 2007 was due to the exchange rate appreciation. By contrast, Shakeri, Gray, and Leonard (2012) find some evidence that the exchange rate appreciation explains only a small part of the relatively weak manufacturing output performance. Governor Carney (2012) noted that only about half of the exchange rate appreciation over the past decade reflects the rise in commodity prices. Moreover, the decline of Canada’s manufacturing share in the economy is a secular trend which is common to other advanced economies.3

3. This paper assesses the causes of Canada’s subpar export growth over the last decade and, in particular, the role played by commodity prices (via the exchange rate).4 This is particularly relevant not only because of the recent commodities boom, but also given that petroleum exports could more than double over the next decades. In addition, we focus on Canada’s export share in the U.S. market, the destination for the vast majority of Canadian exports, and assess what factors have affected the ability of Canadian firms to compete in that market. Our objective is to assess how much of the decline in non-energy, and in particular manufacturing, exports can be related to the boom in commodity prices through their impact on the exchange rate and to the emergence of new powerful competitors such as China. The remainder of this paper is organized as follows. The next section provides an overview of the trade dynamics over the last decades. Section III examines the linkage between commodity prices and the exchange rate. Section IV investigates the extent to which the weaker Canadian exports to the U.S. reflect the stronger Canadian dollar and commodity prices. Section V, presents the conclusions.

B. Canadian Exports Dynamics Over the Past Decades

4. After booming in the 1990s, Canadian exports weakened considerably over the last decade. During the nineties, export volumes expanded at a robust pace of an annual average of 8½ percent boosted by robust U.S. demand. The free trade agreements with the U.S. (CUFTA in 1989 and NAFTA in 1994), also likely helped to preserve Canada’s position as the leading exporter to its southern neighbor throughout the 1990s (Romalis, 2005). However, the export performance deteriorated markedly after 2000, with export growth stagnating up to 2007 and contracting sharply during the time of the financial crisis in 2008–09. Non-energy exports (chart above) have been affected the most, remaining below their 2000 volume levels at the end of 2011; whilst energy exports have continued to expand (chart below).

uA04fig02

Canadian Non-Energy Exports

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Source: Haver Analytics and Fund staff estimates.
uA04fig03

Canadian Energy Exports

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Source: Haver Analytics and authors’ estimates.

5. Manufacturing exports have been among the most hit, while the share of commodity exports has surged. The decline in manufacturing exports explains close to 85 percent of the decline in overall merchandise exports as share of GDP in the 2000s.5 Two major Canadian export sectors—automotive and machinery and equipment—have never fully recovered from the U.S. recession in 2001 (reflecting in part persistently weaker U.S. demand over the last decade). In particular, exports stagnated until 2006–07, and suffered another adverse shock during the 2008–09 global crisis (chart). The forestry industry has also experienced a collapse, reflecting the crisis in the U.S. housing sector, and its export volumes remain 35 percent below 2000 levels. By contrast, commodity exports have continued to expand and now represent about 40 percent of total merchandise exports, twice as large as in early 2000s. Energy exports, in particular, are up 25 percent during the same period and the energy trade balance has risen to a surplus of around 3¼ percent of GDP, compensating the sharp increase in the non-energy trade deficit (3¼ percent of GDP).

uA04fig04

Canadian Main Manufacturing Exports

(Volumes, 2000Q1=100)

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Source: Haver Analytics.

6. The development in the U.S. markets has played a key role in the change of fortune for Canadian exporters. The U.S. is by far the largest destination for Canadian products, absorbing more than ¾ of Canadian exports in the past decades. As such, a weakening U.S. demand is part of the explanation for the challenges faced by Canadian exporters in recent years (see also de Munnik et al., 2012). In particular, the growth of U.S. import volumes decelerated from around 10 percent a year in the 1990s to 4½ percent annually during the period of 2000–07. Over the same period, Canadian average yearly non-energy export growth also fell to a meager 1½ percent. During more recent years, Canadian exporters were also affected by the international crisis in 2008–09, further exacerbating the loss in external markets—non-energy export volumes in 2011 remained 12 percent below 2000 levels.

7. Canadian firms also faced a significant loss of market share in U.S. markets. Between 1999 and 2011, Canada’s market share declined by 5 percentage points to 14⅓ percent of total U.S. imports, a loss equivalent to 6¼ percent of Canada’s GDP. Over the same period, China overtook Canada to become the main exporter to the U.S. (chart). The case of manufacturing exports is particularly striking: while Canadian exports accounted for 20 percent of the total U.S. imports of machinery and transport equipment in1999, the share fell to 10½ percent by 2011.6 In comparison, China’s market share in machinery and transport equipment during the same period surged by 10 percentage points to 25½ percent.

uA04fig05

U.S. Import Shares by Major Trading Partners

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Source: Haver Analytics.

8. In the next sections we investigate what has driven Canada’s declining external competitiveness. A potential explanation is the impact of the sharp rise in commodity prices, which likely fuelled the substantial appreciation of the Canadian exchange rate hurting manufacturing exports. This effect is likely to be more important after 2000 given the rising volumes and prices of energy exports (in addition to metals). Other possible factors include the increasing productivity gap relative to key competitors (see chart below), and tighter competition from emerging economies (e.g., the emergence of China as a world exporter).

uA04fig06

Cross-Country Labor Productivity Comparison

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Source: Conference Board.

C. The Exchange Rate and Commodity Prices

9. This section discusses the sensitivity of the Canadian exchange rate to commodity prices. In particular, we examine the long-term relationship between the Canadian exchange rate and commodity prices. The Canadian real effective exchange rate (REER) seems to be highly correlated with the movements of metal and energy real prices, with the degree of correlation spiking over the last decade (chart). A seminal paper by Amano and van Norden (1995) suggests that there was a negative relationship between energy prices and the relative strength of the Canadian dollar over the period of 1973–1993.7 However, more recent papers argue that this negative relationship has reversed over the past decade or so. For instance, Issa, Lafrance, and Murray (2008) find a positive relationship between the price of energy and the exchange rate from the 1990s onwards. The Bank of Canada argues that the rise in commodity prices accounted for about one half of the appreciation vis-à-vis the U.S. dollar over the past decade, while about 40 percent is due to the multilateral depreciation of the U.S. dollar (Carney, 2012).

uA04fig07

Canadian Exchange Rate vs. Commodity Prices

Citation: IMF Staff Country Reports 2013, 041; 10.5089/9781475587050.002.A004

Sources: IMF, Bank of Canada, Haver Analytics.

10. Our analysis confirms a positive long-run relationship between the Canadian REER and both the energy and metal prices. We test for a long-run equilibrium relationship between the real effective exchange rate and the commodity prices, using a vector error-correction model (ECM) of Canada’s REER:

ΔREERt = α(REERt-1β1Penergyt-1β2Pmetalst-1β3Productivityt-1) + γ1ΔREERt-1 + γ2ΔP_energyt-1 + γ3ΔP_metalst-1 + γ4ΔProductivityt-1 + γ5Δspreadt-4

where ΔREER, ΔP_energy, ΔP_metals, and ΔProductivity are the first differences of the Canadian real effective exchange rate, real energy prices, real metal prices, and an index of Canada-U.S. productivity differential, respectively. The terms in the bracket are the co-integrating equation, measuring the deviation of the system from its long-run equilibrium relationship. The coefficient α is the error-correction parameter, which measures the adjustment speed towards the long-run equilibrium. The spread variable is the Canada–U.S. interest rate spread (see Appendix for description of the data). This regression also includes Canada’s productivity gap with the U.S. Consistent with the Harrod-Balassa-Samuelson hypothesis, it is expected that the opening up of such a gap would exert downward pressures on the Canada’s REER. The results are as follows:

  • The surge in commodity prices (energy and metals) in the 2000–2007 is estimated to have led to an appreciation of the REER by about 25 percent, about three quarters of the total appreciation observed in the period.8 The estimated long-run impacts suggest that a 1 percent increase in the price of energy will lead to around 0.11–0.16 percent appreciation of the Canadian REER, whilst a 1 percent rise in the price of metals will result in a 0.4–0.5 percent appreciation (Table 1).9 As real energy prices grew by 60 percent between 2000 and 2007, this factor alone might have caused the REER to appreciate by almost 10 percent over this period. While significant, such estimates are somewhat lower than in the recent literature.10 We also test the relationship between the exchange rate and a composite commodity price index (a weighted average of metals and energy prices). A 1 percent increase in commodity prices would result in a 0.4 percent appreciation of the REER, although the impact would be somewhat lower if including the financial crisis in the sample period (Table 1, column V). Given that the composite commodity price index rose by 62 percent between 2000 and 2007, the expected appreciation would be close to 25 percent.11

  • There is also some partial evidence of a long-run impact of the productivity gap on the exchange rate. However, the estimated impact is relatively small and is not robust across samples. In particular, the productivity gap vis-à-vis the U.S. would have implied a depreciation of Canada’s REER by ½ percent between 2000 and 2007. The impact of the commodity prices however dominated, and led to a substantial appreciation in the Canadian dollar.

Table 1.

Exchange Rate and Commodity Prices (Vector error-correction model)

article image
*,**,*** indicate respectively statistical significance at the 10, 5, and 1% level.Note: All variables are expressed in logarithms except for interest rate spread, which is the Canada-US 3-month interest rate spread (4 lags). Regressions I to V are based on quarterly data, while VI and VII are using monthly data.

D. What Explains Canada’s Loss of Market Shares in the U.S.?

Methodology and data

11. In this section, we assess the main factors behind Canada’s loss of market share in the US. The focus is on movements of the exchange rate (and commodity prices) and the emergence of China in international trade. We look at market shares, rather than exports volumes, to control for changes in the U.S. demand that affect all exporters. To better identify their impact on Canadian firms’ competitiveness, and quantify which sectors have been the most affected, we look at imports to the U.S. markets using 4-digit levels (SITC) data over 1975–2010. The sector-level trade data also allows us to identify not only the overall effect on Canadian exports, but also which specific sectors are more exposed to the movements in the exchange rate (or commodity prices) and/or competition from China.

Our empirical specification is as follows:

CANi,t = αi + β1REERt + β2CHNi,t + β3Xt

Where CANi,t represents the Canadian share of U.S. imports of good i at time t, while REERt is the Canadian real effective exchange rate, and CHNi,t is the Chinese share of U.S. imports of good i at time t. X is a vector of control variables, including Canadian domestic demand, U.S. GDP growth, and the dummies for the introduction of CUFTA/NAFTA (in some specifications, when statistically significant, we used lags of independent variables).12 A significant negative relationship between the appreciation and the market share in sector i would be evidence in support of a negative effect of the rise in commodity prices on Canada’s market share, given that commodity prices have been the key driver of the movements in the Canadian exchange rate. However, it does not necessarily imply that the higher commodity prices have an overall negative impact on Canada as discussed above. For some regressions we explicitly include commodity prices as an instrument for the exchange rate. The inclusion of China’s share as an independent variable controls for the effect of China’s emergence as a large player in international trade over the last decades. The dynamic panel analysis is based on GMM estimators suggested by Arellano and Bond (1991).13

Results

12. The REER appreciation and the emergence of China had a significant impact on Canada’s non-energy U.S. market share.

  • A 10 percent appreciation of the REER reduces Canada’s non-energy U.S. market share by about 0.6 percentage points on average between 1975 and 2007 (Table 2). The estimated impact is somewhat larger when the regressions include commodity (energy and metals) or energy prices as instrument variables for the REER. This suggests that the rise in commodity prices was key in driving the loss of market share associated with the exchange rate appreciation. The results for the larger sample (1975–2010) show an even stronger impact of movements in the exchange rate on Canada’s market share (Table 2b)—a 10 percent appreciation would lead to 0.8–0.9 percentage point fall in the market share.

  • The competition effect from China is also significant. Canada’s non-energy U.S. market share falls by an estimated 13 basis points for every 1 percentage point increase in China’s share (Table 2). Regressions for the different import groups show that the impact of China varies considerably, and is statistically significant on for those import groups where both countries compete.14 The results suggest that the emergence of China in international trade had a significant impact (in some sectors) that is not being captured by movements in the exchange rate.15

Table 2.

Canada Shares in the US Non-Energy Import Market (1975–07)

article image
*,**,*** indicate respectively statistical significance at the 10, 5, and 1 percent level.The dependent variable is the Canadian share of U.S. imports in the non-energy sector (as defined in the appendix). The independent variables are the log of the contemporaneous Canadian real effective exchange rate (REER), the China share of US imports of manufacturing (comtemporaneous and lag), the lagged Candian domestic demand growth, the lagged US GDP growth and a dummy for CUFTA/NAFTA (takes value 1 for years under CUFTA or NAFTA and zero otherwise). In regression II, the log of commodities prices is used as an instrument for the REER; in regression III, the log of energy price is used as an instrument for the REER.The table presents the long-term elasticities. The standard errors used to test level of significance of the long-term coefficients are based on the delta method.
Table 2b.

Canada Shares in the US Non-Energy Import Market (1975–10)

article image
*,**,*** indicate respectively statistical significance at the 10, 5, and 1 percent level.The dependent variable is the Canadian share of U.S. imports in the non-energy sector. The independent variables are the log of the contemporaneous Canadian real effective exchange rate (REER), the China share of US imports of manufacturing (comtemporaneous and lag), the lagged Candian domestic demand growth, the lagged US GDP growth and a dummy for CUFTA/NAFTA (takes value 1 for years under CUFTA or NAFTA and zero otherwise). In regression II, the log of commodities prices is used as an instrument for the REER; in regression III, the log of energy price is used as an instrument for the REER.The table presents the long-term elasticities. The standard errors used to test level of significance of the long-term coefficients are based on the delta method.

13. The evidence points to an even stronger impact of the exchange rate on Canada’s manufacturing U.S. market share (Table 3).

  • In particular, a 10 percent increase in the REER results in 0.9 percentage point decline in Canada’s manufacturing U.S. market share (columns III and IV). Accordingly, about 2.9 of the 4½ percentage points decline in Canada’s manufacturing U.S. market share between 1999 and 2007 is likely attributed to the REER appreciation over that period. Adding commodity prices as an instrumental variable in the regressions points to a stronger impact of exchange rate movements (columns V and VI)—suggesting that, the appreciation of the exchange rate linked to the rise in energy and metal prices contributed to the loss of competiveness. The larger sample (1975–2010) again shows an even larger impact of the exchange rate and commodity prices on Canada’s market share—a 10 percent appreciation would lead to a 1½ percentage point fall in Canada’s market share (Table 3b). Applying the elasticity to the 2000–2011 period, the appreciation would explain almost 60 percent of Canada’s loss.

  • The REER appreciation did have a material negative effect on Canadian manufacturing exports. A simple counter-factual simulation shows that if the REER had stayed constant between 2000 and 2007, Canada’s manufacturing share in the U.S. market would have been about 16 percent in 2007, rather than the actual 13 percent. Export growth would have been about 2¼ percentage points stronger every year between 1999 and 2007 and manufacturing exports would have been about 2½ percent of GDP higher in 2007.

  • The rise of China as a major trade player also had a negative impact on Canada’s market share. The results (Table 2, columns III to VI) indicate that a 1 percentage point increase in China’s market share led to a decline of about 13 basis points in Canada’s market share. While the elasticity may appear relatively small, the impact on Canada was significant, given the large rise in China’s share over the last decades. In particular, based on the estimated elasticity, the increase of China’s market share in the U.S. explain the 1.9 percentage points decline of Canada’s share (about 40 percent total loss).16 The 1975–2010 sample shows a somewhat larger elasticity (Table 7), but the China’s effect would explain a similar 40 percent of Canada’s loss of market share in the 2000–2011 period.17

Table 3.

Canada Shares in the US Manufacturing Import Market - Panel GMM (1975-07)

article image
*,**,*** indicate respectively statistical significance at the 10, 5, and 1 percent level.The dependent variable is the Canadian share of U.S. imports in the manufacturing sector (as defined in the appendix). The independent variables are the log of the contemporaneous Canadian real effective exchange rate (REER), the China share of US imports of manufacturing (comtemporaneous and lag), the lagged Candian domestic demand growth, the lagged US GDP growth and a dummy for CUFTA/NAFTA (takes value 1 for years under CUFTA or NAFTA and zero otherwise). In regression II and V, the log of commodities prices is used as an instrument for the REER; in regression VI, the log of energy price is used as an instrument for the REER; in regression VII, the log of the productivity differential between Canada and China is used as an instrument for China’s impact; in regression VIII, the log of Chinese productivity is used as an instrument variable for China’s impact.The table presents the long-term elasticities. The standard errors used to test level of significance of the long-term coefficients are based on the delta method.
Table 3b.

Canada Shares in the US Manufacturing Import Market - Panel GMM (1975-10)

article image
*,**,*** indicate respectively statistical significance at the 10, 5, and 1 percent level.The dependent variable is the Canadian share of U.S. imports in the manufacturing sector (as defined in the appendix). The independent variables are the log of the contemporaneous Canadian real effective exchange rate (REER), the China share of US imports of manufacturing (comtemporaneous and lag), the lagged Candian domestic demand growth, the lagged US GDP growth and a dummy for CUFTA/NAFTA (takes value 1 for years under CUFTA or NAFTA and zero otherwise). In regression II and V, the log of commodities prices is used as an instrument for the REER; in regression VI, the log of energy price is used as an instrument for the REER; in regression VII, the log of the productivity differential between Canada and China is used as an instrument for China’s impact; in regression VIII, the log of Chinese productivity is used as an instrument variable for China’s impact.The table presents the long-term elasticities. The standard errors used to test level of significance of the long-term coefficients are based on the delta method.

E. Conclusions

14. Canada’s waning export performance over the last decade reflects to a great extent the high dependence on the U.S. markets, the appreciation of its exchange rate, and a competitive disadvantage vis-à-vis China. The weaker demand from the U.S. over the last decade played a role in the challenges faced by Canadian exporters. At the same time, Canada suffered a stark decline in its market share in the US. The large exchange rate appreciation between 1999 and 2011, driven by the surge in commodity prices, explains close to 60 percent of the fall in Canada’s market share of U.S. manufacturing imports in the same period.18 The increased presence of China as a competitor in the U.S. market explains around 40 percent of the loss. Canada’s response to the new competitive challenges from China and stronger currency has been hindered by the lackluster growth of productivity.

Appendix I. Data Resources

A1. Time-Series Data (annual, quarterly, and monthly)

Real effective exchange rate (REER) based on CPI, computed by the IMF.

Commodity price index: the energy price index and metals price index are from the Bank of Canada, with weights for price index from Canadian trade data. We deflate the commodity price index by U.S. GDP deflator for the quarterly data and with U.S. CPI for the monthly data, to get the real commodity price index.

The Canada-US 3-month interest rate spread is based on the difference between the 3-month Canadian Prime Corporate Paper and the U.S. 3-month nonfinancial commercial paper (both from Haver Analytics).

The Canada-US labor productivity differential is measured by GDP per person employed in 2011 EKS dollar, computed by the Conference Board.

Canada domestic demand is based on national accounts data (Source: Haver Analytics).

A2. Panel Data (annual)

For the panel data regressions, we define the manufacturing sector to be SITC6 plus SITC7 plus SITC8, that is, manufactured goods and machinery & transport equipment. The non-energy sector is computed by excluding SITC3 from the SITC sectors.

SITC (=Standard International Trade Classification) data from Comtrade (United Nations), which are complied and documented in Feenstra et al. (2005).

SITC0 = food and live animals.

SITC1 = beverages and tobacco.

SITC2 = crude materials and inedible except fuels.

SITC3 = mineral fuels, lubricants and related materials.

SITC4 = animal and vegetable oils, fats and waxes.

SITC5 = chemicals and related products.

SITC6 = manufactured goods.

SITC7 = machinery and transport equipment.

SITC8 = miscellaneous manufactured articles.

SITC9 = commodities and transactions not classified elsewhere in the SITC.

References

  • Amano, Robert A., and Simon van Norden (1994), “Terms of Trade and Real Exchange Rate: the Canadian Evidence”, Journal of International Money and Finance, Vol. 14, No. 1, pp: 83104.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Arellano, M., and S. Bond (1991), “Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations”, Review of Economic Studies, 58: 277297.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Baldwin, John, and Wulong Gu (2009), “Productivity Performance in Canada, 1961 to 2008: An Update on Long-Term Trends”, Canada Productivity Review, Economic Analysis Division, Statistics Canada.

    • Search Google Scholar
    • Export Citation
  • Bailliu, Jeannine, and Michael R. King (2005), “What Drives Movements in Exchange Rates?”, Bank of Canada Review, Autumn.

  • Bayoumi, Tamim, and Martin Muhleisen (2006), “Energy, the Exchange Rate, and the Economy: Macroeconomic Benefits of Canada’s Oil Sands Production”, IMF Working Paper, WP/06/70, International Monetary Fund.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Beine, Michel, Charles S. Bos, and Serge Coulombe (2009), “Does the Canadian Economy suffer from Dutch Disease?”, Tinbergen Institute Discussion Paper, TI2009–096/4.

    • Search Google Scholar
    • Export Citation
  • Carney, Mark (2012), “Dutch Disease”, Remarks by the Governor of the Bank of Canada, Spruce Meadows Round Table, Calgary Alberta, September 7.

    • Search Google Scholar
    • Export Citation
  • Cashin, Paul, Luis Felipe Cespedes, and Ratna Sahay (2003), “Commodity Currencies and the Real Exchange”, Central Bank of Chile, working paper No. 236.

    • Search Google Scholar
    • Export Citation
  • Chen, Ruo, Gian Maria Milesi-Ferretti, and Thierry Tressel (2012), “External Imbalances in the Euro Area”, memo.

  • Issa, R., R. Lafrance, and J. Murray (2008), “The Turning Black Tide: Energy Prices and the Canadian Dollar”, Canadian Journal of Economics, 41(3): 737759.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Lascelles, Eric (2012), “Shrugging Off Canada’s Competitiveness Shortfall”, Economic Compass: Global Perspectives for Investors, RBC Global Asset Management.

    • Search Google Scholar
    • Export Citation
  • Medas, Paulo and Daria Zakharova (2009), “A Primer on Fiscal Analysis in Oil-Producing Countries”, IMF Working Paper, WP/09/56, International Monetary Fund

    • Crossref
    • Search Google Scholar
    • Export Citation
  • de Munnik, Daniel, Jocelyn Jacob, and Wesley Sze (2012), “The Evolution of Canada’s Global Export Market Share”, Bank of Canada Working Paper, No. 2012–31

    • Search Google Scholar
    • Export Citation
  • Roodman, David (2009), “A Note on the Theme of Too Many Instruments”, CGD Working Paper No. 125, Center for Global Development.

  • Romalis, John (2005), “NAFTA’s and CUSFTA’s Impact on International Trade”, NBER Working Paper, 11059, National Bureau of Economic Research, January.

    • Search Google Scholar
    • Export Citation
  • Shakeri, Mohammad, Richard S. Gray, and Jeremy Leonard (2012), “Dutch Disease or Failure to Compete? A Diagnosis of Canada’s Manufacturing Woes”, IRPP Study, No. 30, Institute for Research on Public Policy, May.

    • Search Google Scholar
    • Export Citation
1

Prepared by Paulo Medas, based on forthcoming IMF Working Paper by Medas and Dai.

2

Higher commodity prices have a direct positive welfare impact as they mean a transfer of wealth from the rest of the world, and thus higher income for Canadians. In addition, the domestic non-commodity economy benefits from higher demand for services and products from the commodity sector.

3

Governor Carney’s speech on September 7, 2012.

4

In the paper we are focusing on non-renewable commodities that are tradable internationally, as such when we refer to commodities we focus on energy and metals.

5

In this section, manufacturing is broadly defined as including machinery and equipment, transportation, and other consumer goods (from Canada Statistics).

6

As a consequence, while machinery and transport equipment accounted for close to half of Canadian exports to the U.S. in 1999, by 2011 they represented just slightly more than ⅓.

7

By “negative”, we mean that a rise in energy prices leads to a depreciation of the Canadian dollar versus the U.S. dollar.

8

These results are not fully comparable with those found by the Bank of Canada and referred above as the Bank’s study looks at the bilateral rate with the U.S. dollar and at a wider set of commodity prices, including energy and non-energy (metals, forestry, fish, and agriculture) prices.

9

Given our interest is in the long-term relationship, Table 1 only shows the estimates for the cointegrated equation (we omitted the constant in the table).

10

Shakeri, Gray, and Leonard (2012) argue that for the post-2004 period, the exchange rate become more sensitive to commodity prices. They find that a 1 percent increase in energy prices would lead to an appreciation of 0.5 percent (and 0.7 percent for non-energy commodities).

11

Using higher frequency data, after controlling for market volatility (as measured by the VIX), does not change the main results (Table 1, columns VI and VII). Periods of high market volatility (as measured by the VIX index) may also be associated with large fluctuations in commodity prices, which potentially affect the estimates of the REER’s sensitivity to commodity prices.

12

CUFTA is a free-trade agreement (FTA) between Canada and the United States, entered in 1989. NAFTA, replaced CUFTA since 1994, is a free-trade agreement (FTA) among Canada, the United States, and Mexico.

13

The forthcoming Working paper discusses in more detail the regressions and robustness tests.

14

For example, the impact of China seems to be stronger in some areas of manufacturing; while on commodities, beverages, animal products we could not find statistically significant impact as there is limited competition from China.

15

Namely, the regressions captured the effect of changes in the REER (or relative prices), but do not capture the effect from a new entrant in the market that has a significant relatively lower price level (as China). By including China’s share we control for that effect.

16

We tested whether this result reflects Canada and China’s shares reacting to a common shock by introducing instrument variables for China’s share (the productivity lag between Canada and China and China productivity growth). In both cases, the estimated impact of China remains statistically significant and is even larger (columns VII and VIII)

17

The control variables tend to have the expected sign. The introduction of CUFTA/NAFTA had a statistically significant positive (although small) impact on Canada’s market share in most regressions. The domestic demand in Canada also tends to affect negatively exports to the US, possibly due to a substitution effect.

18

In the 1999–2007 period, the appreciation explained slightly more than 60 percent of the market share loss, while China explained slightly more than 40 percent. Other factors (like CUFTA/NAFTA) had a smaller positive impact, only marginally compensating for the appreciation and China emergence.

Canada: Selected Issues
Author: International Monetary Fund. Western Hemisphere Dept.