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Lower dollar no free ticket to economic growth

Canadian dollars.

Ryan Remiorz/THE CANADIAN PRESS

On Jan. 23, the day the Bank of Canada coloured its outlook for the economy in a darker shade of gray, the Canadian dollar was trading at par against its U.S. counterpart.

The shift in the central bank's sentiment has caused currency traders to question whether Canada is such a great haven. According to Peter Hall, chief economist at Ottawa-based Export Development Canada, there's been a "dampening of the halo effect."

So the currency now trades at about 97 cents. It's tempting to read that 3 per cent decline since late January as stimulus by stealth. At one time, the Bank of Canada reckoned a drop of that magnitude was equivalent to a 1-percentage-point decrease in interest rates. That relationship has been discredited , but surely a weaker currency is as good as an interest-rate cut, especially since it benefits exporters without making it cheaper to borrow to buy a house?

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It made sense to some of us around here. And then I asked around. Result: negative. The hypothesis didn't hold up so well outside the confines of the Report on Business newsroom.

Mr. Hall said the old relationship between the currency and interest rates was valuable back in the day only because the central bank used it. As soon as central bankers moved on, so did Mr. Hall.

Derek Holt at Bank of Nova Scotia said much the same. Sébastien Lavoie, a former Bank of Canada economist who now works for Laurentian Bank, said maybe something like a 4 per cent change in the value of the dollar would equate to a quarter-point shift in the Bank of Canada's benchmark interest rate, but he'd have to think about it. I doubt he will. "The relationship no longer really applies," he said by phone from Montreal.

The Canadian dollar's decline represents a windfall for any company that sells goods or services priced in U.S. dollars. That's an immediate bump in the value of sales.

However, it takes time for higher corporate revenue to affect the broader economy.

Mr. Hall says a 10 per cent drop in the currency could boost Canada's gross domestic product by 4 per cent over a period of 18 months to two years. (The loonie has declined about 8.5 per cent against the greenback since touching $1.06 at the end of November, 2011.) But that calculation assumes no headwinds. And Canada is facing plenty, especially from weaker commodity prices. Mr. Hall says whatever boost Canada's economy is getting from a weaker currency likely is being offset by the negative effects of reduced profits in the resource industries.

At Scotiabank, Mr. Holt is unsure the change in the exchange rate is all that meaningful. The loonie's decline has been almost exclusively against the U.S. dollar. The Bank of Canada also tracks the loonie against a trade-weighted basket of currencies that includes the U.S. dollar, the euro, the yen, the yuan, the Mexican peso and the British pound. The Canadian-dollar effective exchange rate index was only 1.5 per cent lower in February than in December. "I don't think the Bank of Canada is so comforted only by a decline against the U.S. dollar," Mr. Holt said from Toronto.

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So what was gained by this exercise? Well, I'm reminded of the value of checking one's assumptions. And I'm reminded that there will be no free ticket back to faster economic growth. The Bank of Canada has stressed both that the Canadian economy is structurally uncompetitive, and that a stronger currency offers executives the opportunity to correct that deficiency. Policy makers in Canada aren't actively seeking a weaker currency. If that changes, we should probably worry.

"If the Bank of Canada cuts rates, it would show that it has decided businesses just aren't going to invest enough to become competitive," said Mr. Lavoie.

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