Regional Business Cycles in Canada: A Regime-Switching VAR Approach

(ProQuest: . denotes formulae omitted.)1.IntroductionIn general, regional business cycles would be expected to mimic national cycles because of the general transmission of cyclical impulses, such as monetary policy or consumer and producer sentiment shocks, through the national economy to the regional level. However, disparities in regional business cycles in Canada could be attributed to either idiosyncratic shocks, such as the price of oil in the case of Alberta, or to differences in the industrial composition of the regions, such as the concentration of manufacturing in central Canada. The purpose of this study is to determine the extent to which provincial and regional economies in Canada move according to a common driving force and the extent to which there are different regional cycle patterns. The analysis of business-cycle synchronization could provide useful information for policy-makers in determining the regions most sensitive to economic shocks or policy changes and the regional business cycles that generally lead the national cycles.This study uses a Markov-switching methodology to capture the asymmetric nature of provincial business cycles in Canada. Regime-switching models have now become useful tools for analyzing the synchronization of national economies, as seen in Artis, Krolzig, and Toro ( 2004), Artis, Marcellino, and Proietti (2004), Camacho, Perez-Quiros, and Saiz (2006), and Krolzig and Toro (2005) for countries in the European Monetary Union (EMU), in Smith and Summers (2005) for other industrialized countries, and for regional economies in the United States as analyzed by Owyang, Piger and Wall (2005), and Hamilton and Owyang (2012). The Markov-switching methodology has an advantage over classical business-cycle approaches that identify business cycles with coincident composite indicators for an economy1 because it offers a joint statistical model for an economy. The methodology measures economic activity as function of a latent (unobserved), stochastic regime variable that indicates whether the economies are in a recessionary or an expansionary phase. This econometric approach can capture important, stylized business-cycle features from a group of economic time series, such as the regime probability, the synchronicity of the business cycles among different economies, the structural break of the business-cycle phases, the transition probabilities from recessions to expansions, the behaviour of volatility in the different business-cycle phases, and the duration of the cyclical phases in each economy. Overall, the regime-switching methodology is able to provide some useful stylized features of the business cycles of different economies.To preview the results, Markov-switching univariate estimations identify two- and three-regime provincial employment cycles. Also, some provincial economies are found to be unsynchronized with the national economy because they do not experience explicit employment-cycle phases. Despite the asychronicity of provincial employment cycles, concordance indices identify a very close cyclical pattern between most of the provinces and Canada as the reference economy, and maximum correlation coefficients indicate that recessions in Ontario lead overall recessions in Canada and in some of the provinces. The Markov-switching VAR models capture common regime shifts in the stochastic process of the employment growth for the two groups of provinces. The regimes are very persistent, with only small probabilities of shifting from one regime to another. The findings in this study suggest that indicators of the business cycles in the largest and most representative region, Ontario, may be a useful policy tool for forecasting national economic activity. However, heterogeneity in the employment cycle for some of the provinces suggests that policies focusing on smoothing provincial or regional fluctuations might be more suitable than general monetary or fiscal policies that focus only on the national business cycle. …