Bank of Canada deputy governor says flexible exchange rate helps economy

EDMONTON — Canada’s flexible exchange rate has helped the economy adjust to external shocks and contributed to low and stable inflation, a senior Bank of Canada official said Monday.

Speaking in Edmonton, deputy governor Lawrence Schembri said while the central bank’s inflation target normally gets most of the attention, the value of the floating dollar risks being overlooked.

“The flexible exchange rate has helped our economy adjust to external shocks, primarily changes in commodity prices,” he told Economics Society of Northern Alberta, according to a text of his remarks released in Ottawa.

“Although our floating currency does not completely offset the impact of all these shocks, it has complemented the bank’s inflation target to help achieve low and stable inflation and keep our economy functioning well.”

Schembri’s comments came as the central bank reviews its inflation control agreement with the federal government ahead of its renewal in 2021. The agreement includes a two-per-cent inflation target and a flexible exchange rate.

“While we’re not going to alter the flexible exchange rate component of our monetary policy framework, it is incumbent on policy-makers to review even successful regimes to ensure that they are serving the best interests of Canadians,” Schembri said.

Schembri said the floating loonie allows monetary policy independence and makes adjustments to external shocks easier.

The benefits of a flexible exchange rate “far exceed” the costs as it contributes to policy clarity and promotes financial sector development, he said.

As an example, Schembri pointed to the recent oil price shock that saw the price plunge from US$103 per barrel in the second quarter of 2014 to US$34 per barrel in the first quarter of 2016, while the Canadian dollar fell from 92 cents US to 73 cents US.

He estimated that had the central bank tried to hold the loonie steady it would have had to raise its policy rate to 6.75 per cent in 2015 and by an additional quarter of a percentage point in early 2016. In reality, the central bank cut its policy rate twice and took it down to 0.5 per cent.

“Those hypothetical rate increases to hold the dollar fixed would have had tremendous adverse effects on the real economy. Instead of stimulating growth with our rate cuts, our rate increases would have lowered the level of gross domestic product by $60 billion by early 2016,” Schembri said.

Canada first abandoned the post-war Bretton Woods pegged exchange rate in 1950, but returned to a pegged rate for a period from 1962 to 1970 before leaving the system for good.

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