1. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 1 “Revisiting the Case for a Flexible Exchange Rate in Canada” John Murray Bank of Canada Presentation to MBA Students at École des Hautes Études Commerciales 7 August 2001

2. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 2 Outline Why a fixed exchange rate might seem attractive Why Canada might need a flexible exchange rate Can flexible exchange rates be trusted? What system would be best for Canada?

3. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 3 Why a Fixed Exchange Rate Might Seem Attractive Globalization and a more integrated world economy Close economic ties between Canada and the United States Launch of the euro and a sense of isolation Latin American interest in dollarization

4. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 4 Why a Fixed Exchange Rate Might Seem Attractive “Collapse” of the Canadian dollar in 1997-98 Research by some persuasive Canadian economists

5. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 5 Why Canada Might Need a Flexible Exchange Rate Asymmetric shocks and the importance of commodity exports: (1) Commodity exports as a share of total net exports (2) Idiosyncratic shocks and Canadian-U.S. differences Nominal wage-price rigidities and the practical benefits of a flexible exchange rate

6. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 6 Why Canada Might Need a Flexible Exchange Rate Monetary policy independence and accountability (1) Canada as a junior partner in any currency union (2) Monetary policy in the U.S. after Greenspan

7. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 7 Can Flexible Exchange Rates Be Trusted? Philosophical differences between free floaters and fixers Common criticisms of flexible exchange rates: (1) Destabilizing speculation (2) Loose fiscal policies (3) Reduced trade and investment activity (4) Slower productivity growth

8. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 8 Can Flexible Exchange Rates Be Trusted? Evidence that flexible exchange rates actually work: (1) The Bank’s magic equation (2) The Asian crisis

9. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 9 What System Would Be Best for Canada? Factors favouring a common currency: (1) Sizable savings in transactions costs (2) Reduced uncertainty and greater economic integration Factors favouring a flexible exchange rate: (1) Insulation from asymmetric shocks (2) Monetary policy independence (3) Political concerns and lessons from Europe

10. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 10 What System Would Be Best for Canada? Conclusion: A flexible exchange rate is our best option for now and the foreseeable future, but conditions change...

11. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 11 Graph 1 Ratio of Nominal Commodity Exports to Nominal GDP

12. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 12 Graph 2 Net Exports of Commodities and Total Net Exports Billions of nominal dollars

13. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 13 Graph 3 U.S. - Canada Exchange Rate

14. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 14 Graph 4 CPI Inflation Rates (y/y)

15. 07/08/01"Revisiting the Case for a Flexible Exchange Rate in Canada" 15