Search

Although the standard of living of Canadians has improved as a result of terms-of-trade gains created by the sharp rise in real commodity prices over the past five years or so, the commodity-price increase, combined with an exchange rate appreciation and real income gain, triggered structural adjustments by altering underlying economic incentives. The frictions generated in adjusting to the relative price shock have likely contributed to hold back aggregate productivity growth. Dupuis and Marcil examine the structural adjustments that have been required-in particular, the resource reallocation among the different sectors of the economy-and its effects on employment, output, and productivity, as well as the responses of final domestic demand and external trade flows.

We study the effects of financial frictions on firm exit when firms face large liquidity shocks. We develop a simple model of firm cost-minimization that introduces a financial friction that limits firms’ borrowing capacity to smooth temporary shocks to liquidity.

This issue features a summary of the Bank’s annual conference, which this year dealt with financial globalization, and three articles that present research by Bank staff on Canada’s mortgage market, the role of adverse selection in financial crises, and payment networks.

Consumption inequality and a low interest rate environment are two important trends in today’s economy. But the implications they may have—and how those implications interact—within different monetary policy frameworks are not well understood. We study the ranking of alternative frameworks that take these trends into account.

The beginning of a new year is a good time for reflection – a chance to look back over the past 12 months and consider what may lie ahead. Certainly, 2009 saw remarkable economic and financial upheaval around the world, which plunged Canada into a severe recession.

The Reports section of the Financial System Review examines selected issues of relevance to the Canadian and global financial systems. The December 2015 issue features two reports on significant developments in the financial system related to household finances: the importance of residential mortgage securitization for Canadian housing finance and the changing patterns of indebtedness of Canadian households.

This monthly newsletter features the latest research publications by Bank of Canada economists including external publications and working papers published on the Bank of Canada’s website.

We evaluate, both empirically and theoretically, the spillover effects that debt-financed fiscal policy interventions of the United States have on other economies. We consider a two-country model with international portfolio rebalancing effects. We show that US fiscal expansions would increase global long-term rates and hinder economic activity in the rest of the world.

Standard monetary models adopt an infinite horizon with discounting. Testing these models in the lab requires implementing this horizon within a limited time frame. We compare three approaches to such an implementation and discuss their relative advantages.

The increase in North American stock prices in 1999 and early 2000 has generated interest in the valuation assumptions that would make these price levels sustainable. Here, commonly used valuation techniques are applied to stock markets in Canada and the United States. For the comparative yield approach, real interest rates (rather than nominal rates) are preferred as the comparator of choice to yields on stock market indexes. The spreads between real interest rates and stock market yields have generally increased over the last two years. The dividend-discount model (DDM) approach provides an analytic linkage between the equity-risk premium and the expected growth of dividends. It suggests that market values (measured at the end of February 2000) could be sustained only by rapid growth of dividends in the future or by the continued assumption of an uncharacteristically low risk premium on equity. The spectacular rise in the value of technology stocks in 1999 is noted (Chart 4), and then the valuation measures for the Canadian stock market excluding the technology sector are examined. When this is done with the comparative yield approach, yield spreads are slightly lower, and for the DDM approach, one does not need to assume as high a growth of dividends or as low a risk premium to validate market valuations. Two effects of the "new economy" on the stock market are noted. One is the lowering of dividend yields, as new-economy technology companies tend to have a high reinvestment rate and a low dividend payout rate. Another relates to the potential for a higher track for the economy's productivity growth, which would mean that higher-than-historical assumptions about future earnings growth would be more plausible. Several explanations for the decline in risk premiums on equity are considered. While short-term volatility in the stock market has, if anything, increased in recent years, low inflation and improved economic performance, along with demographics and investor preferences, may have contributed to a decline in the risk premium demanded by investors. A scenario of rapid growth of dividends in the near term slowing to historical norms in the longer term is examined. While this approach can go partway towards explaining high stock market valuations, it requires assumptions that are outside historical experience.