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Some sophisticated analyses have found that a 25-basis-point cut in the Bank of Canada’s key interest rate will lower the exchange rate by 0.5-0.7 per cent, or roughly half a cent. (Ryan Remiorz/The Canadian Press)
Some sophisticated analyses have found that a 25-basis-point cut in the Bank of Canada’s key interest rate will lower the exchange rate by 0.5-0.7 per cent, or roughly half a cent. (Ryan Remiorz/The Canadian Press)

Don’t look to Carney if you want a lower dollar Add to ...

Some days I feel like the only person in Canada who’s discussing monetary policy. So, I was delighted when economist Erin Weir of the United Steelworkers proposed that the Bank of Canada take steps to stimulate the Canadian economy:

“With inflation subdued, there is no pressure for the central bank to raise interest rates. Indeed, the Bank of Canada could intervene to bring the overvalued exchange rate down to more competitive levels without stoking significant inflation.”

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The Bank of Canada does have some room to maneuver on interest rates, as I have argued. Lowering the overnight rate would have downward pressure on unemployment and still be consistent with the Bank of Canada’s 2 per cent inflation mandate.

Where Weir loses me, however, is in a discussion of moving the Canadian dollar “down to more competitive levels” vis-à-vis the U.S. dollar. Setting aside the question of whether a lower Canadian dollar is a desirable thing, the evidence shows that the Bank of Canada lacks the ability to significantly lower the value of the loonie.

Suppose Mark Carney shocked markets with a surprise 25-basis-point cut in the overnight rate. This would cause the Canadian dollar to fall, but only by a little. My own back-of-the envelope estimates find that Canadian dollars - priced in U.S. dollars - would drop by roughly half a cent. More sophisticated analyses have found that a 25 basis point cut will lower the exchange rate by 0.5-0.7 per cent, or roughly half a cent.

The overnight rate is currently at 100 basis points. Even if we believed we could cut it all the way down to zero and still keep inflation expectations around 2 per cent (unlikely), this would, at most, move the Canadian dollar from $1.01 (U.S.) all the way down to $0.98. This is hardly a significant drop and gets us nowhere near the 80 cent level advocated by Jim Stanford of the CAW.

Now, Mr. Weir was not specific when he suggested the type of intervention that the Bank of Canada should undertake. Perhaps he meant that the Bank of Canada would allow inflation to rise beyond 3 per cent. Or, perhaps he wants something more unconventional, such as the Bank directly intervening in foreign exchange markets by selling Canadian dollars and purchasing greenbacks. However, neither one of these options are available as they would violate the Bank’s current mandate, as set by the Federal government.

The Bank of Canada lacks the power to significantly alter the U.S.-Canadian exchange rate. If, as a country, we wish to see a lower Canadian dollar, we need to look to the federal government.

 

 

Mike Moffatt is an Assistant Professor in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business – Western University

 

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