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01031-9781451878004.Pdf © 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. The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information. To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to [email protected]. Copies of this report are available to the public from International Monetary Fund ● Publication Services 700 19th Street, N.W. ● Washington, D.C. 20431 Telephone: (202) 623 7430 ● Telefax: (202) 623 7201 E-mail: [email protected] ● Internet: http://www.imf.org Price: $15.00 a copy International Monetary Fund Washington, D.C. ©International Monetary Fund. Not for Redistribution This page intentionally left blank ©International Monetary Fund. Not for Redistribution 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 Pages PART I: REAL SECTOR ISSUES I. Factoring In Canadian Cycles........................................................................................8 A. Factor Analysis .....................................................................................................9 B. Results.................................................................................................................10 C. Robustness Checks..............................................................................................17 D. Conclusions.........................................................................................................18 References................................................................................................................................19 II. The Effects of U.S. Shocks on the Canadian Economy: Results from a Two-Country Model ...........................................................................................23 A. Introduction and Summary .................................................................................23 B. Model Description ..............................................................................................24 C. Data and Estimation............................................................................................25 D. Results.................................................................................................................26 E. Conclusions.........................................................................................................27 References................................................................................................................................27 PART II: FISCAL ISSUES III. Jam Today or More Jam Tomorrow? On Cutting Taxes Now Versus Later...............34 A. Introduction.........................................................................................................34 B. The Model and Calibration.................................................................................34 C. Results of Cutting Transfers and Lowering Taxes Immediately or Later ..........37 D. Fiscal Spillovers..................................................................................................40 E. Conclusions.........................................................................................................43 ©International Monetary Fund. Not for Redistribution - 2 - References................................................................................................................................43 IV. How Do Canadian Budget Forecasts Compare with Those of Other Industrial Countries...................................................................................45 A. Introduction and Summary .................................................................................45 B. The Institutional Environment for Budget Forecasts..........................................46 C. Fiscal Forecasting Practices in International Comparison..................................56 D. Assessing Forecast Accuracy..............................................................................60 E. Statistical Analysis of Forecast Outcomes..........................................................71 F. Conclusion ..........................................................................................................82 References................................................................................................................................83 PART III: STRUCTURAL ISSUES V. How Flexible is the Canadian Economy? An International Comparison....................92 A. Introduction.........................................................................................................92 B. Industry Data.......................................................................................................92 C. Firm-Level Data..................................................................................................96 D. Macroeconomic Data..........................................................................................97 E. Conclusions.........................................................................................................99 References................................................................................................................................99 PART IV: FINANCIAL SECTOR ISSUES VI. Large Banking Groups and Financial System Soundness .........................................102 A. Overview...........................................................................................................102 B. Banking Sector Trends......................................................................................102 C. Market-Based Financial Soundness Indicators.................................................106 D. Soundness Indicators in Canada and the United States ....................................109 E. Summary...........................................................................................................110 References..............................................................................................................................110 VII. Competition in Canada’s Banking System ................................................................112 A. Introduction.......................................................................................................112 B. Optimal Level of Bank Competition: A Review of the Literature ...................112 C. Methodology and Data......................................................................................113 D. Results...............................................................................................................114 E. Conclusions.......................................................................................................118 References..............................................................................................................................118 ©International Monetary Fund. Not for Redistribution - 3 - Boxes IV. 1. Equalization Transfers in Canada.......................................................................53 2. Fiscal Forecasting Arrangements in Canada.......................................................55 3. Forecasting, Performance, and Budget Debate in New Zealand ........................60 V. 1. Indexes of Structural Changes ............................................................................94 VI. 1. Changes to Canada’s Financial Sector Legislation...........................................103 Tables I. 1. Variance Decomposition for the United States from a Factor Model with Two External and Two Domestic Factors ............................................12 2. Variance Decomposition for Canada from a Factor Model with Two External and Two Domestic Factors ............................................13 IV. 1. Indicators of Relations Between Legislature and Executive ..............................47 2. Share of Spending by Sub-National Governments.............................................49 3. Consolidated Central Government Expenditure Shares, 2003 ...........................51 4. Fiscal Policy Rules and Transparency Laws ......................................................54 5. Key Institutional Characteristics of the Fiscal Forecasting Process...................57 6. Fiscal Forecasting: Quality Assurance................................................................58 7. Descriptive Statistics of One-Year Budget Forecast Errors, 1995–2003 ...........65 8. Results of Forecast Error Median and Mean Tests.............................................72 9. Results of Efficiency Tests .................................................................................74 10. Comparing Budget and Consensus Forecasts.....................................................76 11. Potential Factors Affecting
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