E When It Comes To The Canadian Dollar The Bank Of Canada Is Caught Between A Rock And A Hard Place

As if managing monetary policy is not enough of a challenge, the Bank of Canada has to keep watch on the soaring Canadian dollar at the same time that the economy continues to languish during COVID-19 lockdowns. Currencies never move independently but against each other. Over the past 12 months, the US dollar has declined by approximately 8% against a basket of currencies, including the Canadian dollar. (Figure 1). After reaching a low of US$0.69, the loonie has been on a steady march upwards and currently trades at US$0.79, creating a real dilemma for the Bank of Canada.

(Click on image to enlarge)

Figure 1 Canadian Dollar/ US Dollar Exchange Rate

Re-iterating a long-standing Bank policy, Governor Tiff Macklem made it abundantly clear that:

We don’t target the value of the Canadian dollar. We don’t have an objective for the Canadian dollar. We have an objective for the inflation rate. But the exchange rate is a very important relative price in our economy and it affects the competitiveness of our exports. It also affects the competitiveness of other countries’ exports into Canada.” (Dec 16, 2020)”

Exchange rates are a double-edged sword when it comes to dealing with inflation. A rising exchange rate, such as we have seen over the past year, has suppressed increases in the price of imports, supporting the Bank’s inflation goals. Viewed from the export side, the rise in the Canadian dollar is not welcomed, hence the Bank’s dilemma. As the Governor explains:

“When our currency changes for reasons that are unrelated to Canada, in that case, it’s not acting as a shock absorber,” he said. “It’s becoming a force in its own right. It’s not offsetting something else; it’s becoming a force in the economy.”

The rise in the Canadian dollar affects both the trade and the capital accounts (the net flows of foreign investment). Canada’s current trade account deficit decreased over the past year because of shrinking levels of both imports and exports (Figure 2).  

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William K. 1 week ago Member's comment

Very interesting and educational. Thanks for the post.

Norman Mogil 1 week ago Author's comment

My pleasure

Arthur Donner 1 week ago Contributor's comment

nice article Norm

The C$ certainly is too strong for the Canadian economy at this time.

But as you point out, its strength is really the mirror image of the US dollar weakness.

The Fed also does not target its currency.