1. Exchange Rate and International Trade
Informetrica Limited
Exchange Rate and International Trade
Michael C. McCracken
Informetrica Limited
8 October 2003
Senate Finance Committee
8/6/2019

2. What Do We Know? Exchange Rate changes will affect: Changes take time
Informetrica Limited
What Do We Know?
Exchange Rate changes will affect:
Export Prices
Import Prices
Changes take time
Other prices will also change
Real responses may occur
Total effects must consider why the exchange rate changed initially
The exchange rate is the price of a US dollar in Canadian dollars, or conversely the price in US$ to buy one Canadian dollar. It is a price for one monetary unit in terms of another.
8/6/2019

3. Other Considerations What kind of monetary policy “rule” is in place?
Informetrica Limited
Other Considerations
What kind of monetary policy “rule” is in place?
How persistent is the exchange rate change expected to be?
Does the economic system behave similarly to appreciation and depreciation?
Large changes and small changes?
Will the Bank of Canada ease interest rates in order to keep the monetary conditions index unchanged, or will it welcome the additional restraint on prices from the appreciating exchange rate?
8/6/2019

4. Why this Question Now? Table showing exchange rate changes since 1990
Informetrica Limited
Why this Question Now?
Table showing exchange rate changes since 1990
Depreciation through 2002
Recent appreciation
Concern about US pressure for us (and China) to appreciate
Weakness in Canadian manufacturing and resources – help from a lower dollar?
We have depreciated against the US dollar since 1991 by about 30% by 2002 and appreciated by about half of that since the beginning of Is the concern that we remain 15% below the 1991 levels or that we have appreciated recently? Is the 1991 level special? What about parity???
The US pundits claim we have been part of their problem, depreciating to maintain our employment while they suffer a recession. They should be happy about current developments, although they always want more.
The US current account deficit is large by any standard. It is unsustainable, but that does not mean that there currency will necessarily depreciate as much as some think is desirable. (Another 20-30%).
8/6/2019

5. Informetrica Limited
Exchange rate changes
8/6/2019

6. Interconnected system
Informetrica Limited
Interconnected system
Canadian Economy
CAN/US Exchange Rate
US Economy
Recognize that the world is an interconnected system. The US economy will influence our exchange rate with them, the development of the Canadian economy, and even our policy choices.
Canadian Policies
8/6/2019

7. Informetrica Limited
20% appreciation:
Export & import commodity prices – 20% decline quickly
Other export and import prices – decline of 10-15% over several years
Corporate profits down relatively
CPI lower, import-competing prices down
Wage increases moderate
M&E prices down
If the exchange rate correction remains at 75 US cents per Canadian dollar, then eventually the CPI will be about 10% lower than it would otherwise have been with a 63 US cent dollar. Over a five –year period this would be a positive help in ensuring low inflation.
8/6/2019

8. Real effects Real wages up Real disposable income and consumption up
Informetrica Limited
Real effects
Real wages up
Real disposable income and consumption up
Real imports up
Real exports ?
US prices for Canadian goods higher (-)
US depreciation positive for industry demand (+)
Investment ?
Forces are going in two directions in some cases. Lower investment prices encourage investment, but weaker output growth and lower corporate profits in some sectors will hold back investment needs.
8/6/2019

9. Other Macro Indicators
Informetrica Limited
Other Macro Indicators
Inflation lower
Interest rates lower
Current account balance weakens
Real GDP - ?
Unemployment - ?
Government balances – federal down, provincial up
8/6/2019

10. Informetrica Limited
What is happening?
Story I – US depreciation against all major currencies, with Canada following but less so. Net result is Canada appreciates versus US $ (Sideswipe)
Story II – Fundamentals in Canada are wonderful and finally coming through in exchange rate
Story III – Special Factors
All three stories are probably true. The question is their relative importance and what other stories will emerge in the coming years.
8/6/2019

11. Why a US depreciation? “Unsustainable” Current Account?
Interest rates low
Increased international frictions lessen desire to hold US assets
California – governance concern?
8/6/2019

12. Why a Canadian appreciation?
Informetrica Limited
Why a Canadian appreciation?
Relative inflation performance
Higher Canadian interest rates
Expected growth higher
Commodity prices expected up
Current Account and Long-term capital flow balance relatively stronger than US
Review of these elements suggest a persistence of appreciation, at least from Canadian side
8/6/2019

13. Special Factors Quebec separation threat less New opportunities
Informetrica Limited
Special Factors
Quebec separation threat less
New opportunities
Lower Churchill
Alaska Highway Gas Pipeline
BC gas discoveries
New PM?
Reversal of negatives
SARS over, “mad cow” no more, Blackout not Canadian origin
8/6/2019

14. Canadian policy directions
Informetrica Limited
Canadian policy directions
Lower interest rates
Encourage investment
Expand export opportunities
Follow-up on expanding opportunities
Encourage employment
Fiscal dividends from lower inflation and lower interest rates will help provincial governments
In essence, the forces of appreciation should call out policies to promote growth.
Businesses will be under pressure to increase their productivity to remain competitive.
Consumers will have improved incomes, particularly if employment can be maintained.
The more productivity can be enhanced the better the long-term payoff from the appreciation. We have earned much of the appreciation to date with substantial progress on productivity and lower inflation. We need to continue that effort, with greater attention to achieving full utilization of our resources – particularly people – through full employment.
Recall the period of substantial US progress in the last half of the nineties coincided with an appreciating currency, a move to full employment, rapid productivity growth, and improving fiscal circumstances. This is not beyond our reach.
8/6/2019