the canadian dollar and canada’s trade with the united states: recent developments by john murray...
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The Canadian Dollar and Canada’s Trade with the United States:
Recent Developments
byJohn Murray
Bank of Canada
Presentation to the Standing Senate Committee on Foreign Affairs
Ottawa, 7 October 2003
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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
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Putting the Recent Appreciationin 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 1975-2003 period (Graph 3)
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Putting the Recent Appreciationin 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
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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)
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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
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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)
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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
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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
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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
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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
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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
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Canada’s Main Trading Partners : 2002
(using current dollars data on merchandise trade)
Share of Exports Share of Imports
United States 83.75% 71.52%
United Kingdom 1.51% 2.89%
Other E.U. 3.98% 7.26%
Japan 2.48% 3.29%
Other O.E.C.D. 2.98% 5.52%
All Other 5.30% 9.52%
Total 100.00% 100.00%
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Structure of Canada’sMerchandise Trade : 2002
(using current dollars data)
Share of Exports Share of Imports
Agriculture 7.46% 6.11%
Energy 11.96% 4.64%
Raw and industrial materials 25.93% 20.20%
Machinery and equipment 23.49% 29.70%
Automobile products 23.42% 22.85%
Other 7.74% 16.50%
Total 100.00% 100.00%
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