An Anatomy of Governor Stephen Poloz’s Speeches for Canadian International Finance J.D. Han King’s University College at Western University January 10, 2016

 Canada will continue to have weak International Demand for Resources and Exports.  Canada cannot afford to raise Interest Rates. <- Why? -> What will be its effect on International Finance of Canada?  Canadian dollar will continue to loose the value against FOREX.  Falling value of Canadian dollar may provide cushioning to the worsening economy -> Under what conditions may this NOT be relied upon?  Canadian Industrial Structure will change -> from ‘resource’ to ‘resourcefulness? How? And when? Key Points and their Analysis

 get-used-to-lower-dollar-higher-inflation-Poloz- says.aspx get-used-to-lower-dollar-higher-inflation-Poloz- says.aspx  business/economy/canadians-should-get-used-to-lower- dollar-higher business/economy/canadians-should-get-used-to-lower- dollar-higher Listening to him and his commetators speaking:

 “terms of trade” is the ratio of the prices a country receives for its exports to the prices it pays for its imports.  A falling terms of trade, on the other hand, means less export revenues and more import payment, and thus less net income for the country overall.  X-M is falling rapidly due to a falling oil export revenue. Worsening Canadian ‘Terms of Trade’

 “Canada’s economy is directly affected by what is happening in China, where a weaker appetite for resources is depressing prices for oil, coal, copper and many of the key commodities that dominate this country’s exports and investments.”  Close relationship between Oil Price, (Exports), (X-M), and Canadian Dollar’s External Value(against major currencies). Weakness of Exports, and Canadian Dollars

 Recall the theory below, and indicate what is changing for the Canadian case: What else is contributing a Weak Canadian dollar? Supply of FOREXDemand for FOREX Trade Balance Current Account XM Financial AccountCapital InflowsCapital Outflows Above-the-Line BP BalanceX+ KI – (M+KO)>0 BP Surplus X+KI – (M+KO) = BP Equilibrium X+KI – (M+KO) <0 BP Deficits Downward Pressures on FOREX rateUpward Pressures on FOREX rate Changes in Official FOREX Reserve Official Reserves Down Official Financial Inflows Official Reserves UP Official Financial Outflows Question: Use the table above and explain which factors contribute to the current depreciation of Canadian dollar. What government policies affect those factors?

 When U.S. interest rate is going up as QE for 2006 Financial Crisis has ended,  Bank of Canada cannot afford to hike up interest rate due to concern for domestic investment and rapid falling exports.  ->Poloz says that Canada may even go for negative interest rates.  ->Impacts on our International Investment Inbound and Outbound?  ->And the external value of Canadian dollars? U.S. and Canadian Monetary Policies ‘Diverge’:

 Tells us the relationship between Monetary Policy and FOREX rate: East Monetary Policy /Money Supply Up -> (real) Interest Rate Down : “Liquidity Effect” -> International Investor pulls out Capital from Canada to U.S. -> Capital/Financial Outflows -> Domestic Currency Demand falls and FOREX Demand rises -> Domestic Currency depreciates; FOREX appreciates Comments: -Does Money Supply Up leads to Interest Rate Down at all times? <- Inflation Expectations Effect says MS up leads to (nominal) i up as well. -> In the short-run, liquidity effect > expectations effect - We will cover this later. * International Financial Theory of Determination of FOREX Rates

 Not long. **How long can Canadian monetary policy and interest rate diverge from U.S. MP and i?

 The external value of our Canadian dollar has fallen, and will keep falling.  Poloz hopes that this may help boost the domestic ___________investment through _______ interest rates, and boost the international _____________ through the Marshall Lerner condition. FOREX Rate has risen and will rise

 Short-run -Exports and Imports -Employment, National Income in the short-run -Price; Inflation  Long-run Impacts -Exports and Imports -Industry Structure and Productivities -Employment and National Incomes Impacts of a Falling Canadian Dollar Value on the Canadian Economy

 Marshall Lerner Condition A depreciation of the domestic currency (when FOREX rate or ‘e’ goes up) may improve NX(Trade Balance) if Elasticity of Export + (absolute value of) Elasticity of Imports > 1. Short-run Impacts of a Falling Canadian Dollar Value on the X-M

 X – M is in fact  X – e M, where e is FOREX rate. Differentiating both side by e, we get dX/de – 1 – dM/de > 0 dX/de – dM/de > 1 Intuitively, when ‘e’ goes up by 1%, the left side is the benefits (X up and M down); the right side is the cost (import price goes up by 1). proof]

 Mr. Poloz says that in Canada, the Marshall Lerner condition is met unlike some other country(such as U.S.)

 Bank of Canada let FOREX rate go as the Market dictates because a cheaper Canadian dollar or a higher FOREX rate in Canada helps boost Exports (quantity) and reduce Imports (quantity).

 dX/de may take longer than dM/de->  ‘J Curve”: While the additional burden due to changing FOREX rate is immediate, it will take time for X and M will take time to adjust-> Before X-M improves, it will get worse. (still, X-M will rise in the end if the Marshall Lerner condition works) X-M Time

It may not be the case, though,

And “Pass-Through” Inflation Domestic inflation rate = F(domestic excess demand pressure)+ G(world inflation rate + FOREX appreciation) Increasing Payments for Imports may be the first thing to be felt.

 Read Jose Campa and Linda Goldburg, “Exchange Rate Pass- through into Import Prices”, RES (2005) )What is the ratio of d% of Import Prices/ d% of FOREX rates for Canada for the short-term and the long-term respectively? 2)If the exchange rate changes by 35% in the Canadian economy, what will be the change in import prices in the short-run? Pass Through

 “The cost to the country’s economy is $50-billion a year or $1,500 per person.”

What will happen to X-M in the long- run?

 Andrew Rose, “Roles of FOREX rates…: Does ML condition work?”, JIE(1996) Z-main.pdf?_tid=59637cf2-b82f-11e5-91a aab0f6c&acdnat= _b593fdeb5ab497420a3832 e40015fbf1  Andrew Rose, “Is there a J-curve?”, JME(1989) Empirical works indicate that in the long-run, Exchange Rates and Trade Balance may not be consistently related.

 A falling Canadian dollar value may be a ‘shot in the arm’.  Usually, a shot in the arm hampers efforts for an arduous search for Long-term Change.  How can a falling Canadian dollar with a low interest rate lead to a rebuilding of the Canadian economy? What did he say? Then, where would the Long-term Growth come in the Canadian economy?