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Explore the effects of higher energy prices on the Canadian dollar, regional and sectoral adjustments, and implications for monetary policy. Gain insights on economic factors underlying the appreciation and adjustment responses in various sectors.
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“Adjusting to a Higher Canadian Dollar” Presentation to a conference organized by Global Insight Toronto, Ontario13 September 2005 John Murray Adviser to the Governor
OUTLINE • Putting the appreciation in perspective • Economic factors underlying the appreciation • Effects of higher energy prices on the dollar • Regional and sectoral adjustments • Implications for monetary policy
Putting the Appreciation in Perspective • Movements in the Canadian dollar over the last 30 years (Chart 1) • Movements of the Canada dollar relative to other currencies (Chart 2 and 3) • Bilateral versus effective exchange rate measures (Chart 4) • The importance of the Can-US dollar exchange rate to Canada
Economic Factors Underlying the Appreciation • Canada as an important commodity producer and exporter • The “magic” Bank of Canada exchange rate equation • Recent forecast errors and the role of energy (Chart 5) • Other factors that might be at play – global imbalances and productivity • Simulations with modified specifications of our equation (Chart 6 and 7, and Table 1)
AvN MAvN BDS HILZ -0.15 (0.03) 2.08 (0.34) -- -0.44 (0.07) 0.09 (0.04) -- -- -0.66 (0.12) -- 0.22 1.26 -0.18 (0.04) 3.29 (0.56) -0.90 (0.47) -0.47 (0.07) -0.17 (0.10) 0.21 (0.04) -- -0.60 (0.13) -- 0.28 1.43 a a' COMt-1 ENERt-1 ENER1t-1 PRODt-1 INTDIFFt-1 USCURt-6 Statistics R2 DW -0.11 (0.03) 2.84 (0.54) -- -0.50 (0.11) 0.01 (0.05) -- -- -0.58 (0.14) 0.64 (0.16) 0.30 1.59 -0.16 (0.04) 2.77 (0.37) -- -0.51 (0.08) -- -- 0.82 (0.32) -0.59 (0.14) -- 0.22 1.36 Table 1 Real Exchange Rate Equations: 1973Q1-1999Q4a a. Newey-West HAC standard errors in parentheses with p-values larger than 0.10 denoted in bold. 1. The real variables ENER and COM are defined as the nominal U.S. dollar price for energy and non-energy commodities divided by the U.S. GDP deflator.
The Effects of Higher Energy Prices on the Economy • Potential benefits – higher investment, higher oil revenues, higher tax revenues, higher royalty payments, higher net wealth and an improvement in our terms of trade • Potential costs – reduced household disposable income, higher production costs, lower profits (outside the energy sector), short-run adjustment costs, regional and sectoral imbalances • Canada as a major energy exporter – short term costs versus long-term gains
Regional and Sectoral Adjustments • The effects of higher energy and non-energy commodity prices • Favoured regions mainly (but not exclusively) in the west • Favoured sectors mainly (but not exclusively) in the resource and distribution sectors (Chart 8 and 9) • Adjustment response of the tradeables manufacturing sector (Table 2) • How is the adjustment proceeding? Some encouraging signs
Chart 8 Effects of Appreciation by Sector
Chart 9 Firms Adversely Affected: Main Reactions (56 Firms)
Table 2 * Includes sectors that are exposed as net importers.
Implications Policy • One country, one monetary policy and one floating currency • Facilitating short-run adjustment, recognizing transitional effects on capacity • Type 1 versus type 2 fundamental forces acting on the exchange rate • Exchange rate movements, the output gap, and inflation
References Amano, Robert and Simon van Norden (AvN). 1993, “A Forecasting Equation for the Canada-U.S. Dollar Exchange Rate.” The Exchange Rate and the Economy. Bank of Canada. Bailliu, Jeannine; Ali Dib and Lawrence Schembri (BDS). 2005. “Multilateral Adjustment and the Canadian Dollar.” Presented at the 2005 meetings of the Canadian Economics Association. Helliwell, John; Ramzi Issa; Robert Lafrance and Qiao Zhang (HILZ). 2004. “NEMO: An Equation for the Canadian Dollar.” Presented at the 2005 meetings of the Canadian Economics Association.