A VAR Analysis of Economic Interdependence: Canada, the United States, and the Rest of the World

The authors use vector autoregression (VAR) modelling techniques to examine the response of the domestic economy to foreign influences and to quantify some of the concepts and relationships relating to economic interdependence. Particular attention is given to the dynamic behaviour and interactions of the U.S. and Canadian economies over the past twenty years. Extensive empirical analysis reveals that U.S. variables are affected by international variables to a greater extent than many would think. While the Canadian economy is evidently more open than the U.S. economy, and therefore more vulnerable to external shocks, at least 20 to 30 per cent of the forecast variance of U.S. output and prices can be attributed to innovations in foreign variables. The authors also find that the shift from a fixed exchange rate regime to a flexible exchange rate regime did not seem to influence the behaviour of the time series for the variables studied.