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The Canadian Dollar and Canada’s Trade with the United States: Recent Developments by John Murray Bank of Canada Presentation to the Standing Senate Committee.

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Presentation on theme: "The Canadian Dollar and Canada’s Trade with the United States: Recent Developments by John Murray Bank of Canada Presentation to the Standing Senate Committee."— Presentation transcript:

1 The Canadian Dollar and Canada’s Trade with the United States: Recent Developments by John Murray Bank of Canada Presentation to the Standing Senate Committee on Foreign Affairs Ottawa, 7 October 2003

2 2 Introduction Renewed interest in exchange rate volatility and trade Four major messages in my presentation: 1)the recent moves have not been that unusual 2)fundamental and unavoidable forces are probably at work 3)there is an up side to a stronger dollar 4)a floating exchange rate is still the best option for Canada

3 3 Putting the Recent Appreciation in Perspective Sharp appreciation of the Cdn. dollar in the spring of 2003 (Graph 1) Part of a more general appreciation against the US dollar (Graph 2) Similar to other movements over the period (Graph 3)

4 4 Putting the Recent Appreciation in Perspective (cont’d) Cdn. dollar typically more stable than other floating currencies (Graph 4) Real vs. nominal movements and Canada’s competitiveness (Graph 5) The importance of the bilateral Can-US exchange rate to Canada

5 5 Possible Causes of the Appreciation A strong Canadian economy, rising world commodity prices, and an improving outlook for the global economy Broad movements in the Cdn. dollar are usually driven by fundamentals The Bank’s exchange rate equation and four critical variables -- interest rates, inflation and two commodity prices (Graph 6) Unsustainable trade deficits in the US and a need to rebalance the global economy; Asia as an importance challenge (Graphs 7-10)

6 6 Canada’s Trade with the US The importance of trade for the Canadian economy, and greater integration of the North American economy post-NAFTA (Graphs 11 and 12) Structural differences between the Cdn. and US economies, and the importance of commodities

7 7 Canada’s Trade with the US (Cont’d) Steady improvement in Canada’s trade balance and net foreign investment position since mid-1990s (Graphs 13 and 14) Factors that have contributed to Canada’s strong external position (and recent weakness)

8 8 Effects of an Appreciation on Canada’s Trade Canada’s net exports and movements in the real exchange rate (Graph 15) The uneven impact across industrial sectors -- exports and imported inputs as a share of production, and import competition

9 9 Effects of an Appreciation on Canada’s Trade (cont’d) Machinery, electrical and electronic products more exposed, while food, beverage and refined petroleum products are less exposed Advantages of a stronger Cdn. dollar -- an improvement in our terms of trade; cheaper imports and potential productivity gains

10 10 Pros and Cons of Alternative Exchange Rate Regimes The advantages of a flexible exchange rate – policy independence and (partial) insulation from external shocks The limited costs of short-run exchange rate volatility The costs of pegged exchange rates and other semi-fixed arrangements -- increased vulnerability to financial crises

11 11 Pros and Cons of Alternative Exchange Rate Regimes (cont’d) New research on common currency arrangements -- Europe and the euro as an interesting experiment Border effects and the (un)importance of separate currencies

12 12 Conclusion The exchange rate typically moves in response to broad fundamental forces Some rebalancing of world trade and economic activity in Canada is necessary and desirable It is important to take a broad perspective on trade and exchange rate developments, and not view the exchange rate in isolation Alternative exchange rate systems hold little attraction for Canada at the present time

13 13 Canada’s Main Trading Partners : 2002 (using current dollars data on merchandise trade) Share of ExportsShare of Imports United States83.75%71.52% United Kingdom1.51%2.89% Other E.U.3.98%7.26% Japan2.48%3.29% Other O.E.C.D.2.98%5.52% All Other5.30%9.52% Total100.00%

14 14 Structure of Canada’s Merchandise Trade : 2002 (using current dollars data) Share of ExportsShare of Imports Agriculture7.46%6.11% Energy11.96%4.64% Raw and industrial materials25.93%20.20% Machinery and equipment23.49%29.70% Automobile products23.42%22.85% Other7.74%16.50% Total100.00%

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