Canada's Monetary Policy Transmission: Sectoral Responses Reveal Complex Economy

Monetary policy in Canada has a profound impact on business investment across various sectors. This is according to new research from the C.D. Howe Institute, which analyzed data from 1997 to 2024. The study, led by Jeremy M. Kronick and Wendy Wu, found that different sectors respond with varying speeds and magnitudes to monetary policy shocks.

The researchers employed a newly constructed Canadian monetary policy shock series, which incorporates conventional and unconventional policy actions, as well as scheduled and unscheduled Bank of Canada announcements and speeches by senior officials. The study focused on three major investment categories: construction, machinery and equipment (M&E), and intellectual property (IP).

At the aggregate level, investment falls in response to monetary policy tightening, with a significant impact from the level factor, which represents shifts in the entire curve. However, at the next level of granularity, results for structures, M&E, and IP investment are consistent with aggregate investment, with larger and more significant effects from the level and slope factors.

The study also found that leverage affects the strength of monetary policy transmission, and that monetary policy affects investment differently depending on the stage of the business cycle. The researchers concluded that understanding how monetary policy propagates through the economy is central to assessing its effect on aggregate demand and inflation and designing more effective policy.