The Role of U.S. Interest Rates in Canadian Interest-Rate Equations: An Exploratory Analysis

In this study the authors examine in detail the relative importance of U.S. and Canadian interest rates in the determination of three Canadian short-term interest rates: the term-deposit rate, the rate on finance company paper and the prime loan rate. The main technique used is regression analysis on weekly interest-rate data for the period 1963-75. Monthly and quarterly equations are also presented for comparison. A second approach employs principalcomponents analysis to isolate the independent variation of Canadian interest rates that is not explained by movements of U.S. rates. Throughout the study, careful attention is paid to structural changes over the period that have affected the behaviour of Canadian interest rates. In the course of the analysis the authors also examine the determination of the forward premium of the Canadian dollar. The general conclusion is that U.S. interest rates are more important in the determination of the interest rate on Canadian finance company paper than in the determination of the Canadian term-deposit rate, a result that is consistent with the fact that foreigners hold a substantially larger share of Canadian finance paper than of Canadian term deposits.