International Transmission of Fiscal News Shock: Evidence from Defense Spending

Abstract

ABSTRACT This paper proposes a novel fiscal news shock transmission channel from the US to Canada. The US and Canada have a long history of strong political and economic ties. This high degree of economic and political interdependence between Canada and the US makes the Canadian economy sensitive to policy changes in the US. We demonstrate that a fiscal news shock originating from a significant increase in US defense spending can directly transmit to Canada through enhanced defense spending in Canada. We construct a transmission model containing the defense spending news variable to assess the transmission of a fiscal news shock through this novel channel. Our findings suggest that news about increased US defense spending induces Canadian defense spending to rise. Consequently, this increased defense spending has a positive impact on the Canadian GDP. The estimated international fiscal multiplier for Canada is 0.11. We coin a novel fiscal multiplier labeled as the international defense multiplier, which quantifies the response of defense spending of a country due to a change in defense spending in another country.