Trend-Cycle Interactions and the Subprime Crisis: Analysis of US and Canadian Output

Abstract

In the following paper a simultaneous unobserved components model is applied to USAmerican and Canadian output data in order to examine the causal structure of trend and cycle shocks and the way it changes over time. The main focus is placed on the analysis of the subprime crisis impact on the trend and cycle components. The structural model is identified by means of heteroscedasticity. During the subprime crisis for both countries we determine the strong increase of the structural trend variance compared to the previous period. This underlines the permanent effect and, thus, structural problems as a potential cause. Moreover, the both components are more volatile in the Canada than in USA. A further similarity between both countries is the complete disappearance of the structural cycle shock volatility.