THE EXCHANGE RATE REFERS to the value of the
Canadian dollar against the currencies of other
countries. Among other things, it helps
determine how much we pay for imported goods and
services and how much we receive for what we
export.
When the value of the Canadian dollar falls,
imported goods become more expensive, and we
tend to reduce the volume of our imports. At the
same time, other countries will pay less for
some of our products and that will tend to boost
export sales.
The
exchange rate plays a particularly important
role in our economy because, compared with other
countries, imports and exports are a relatively
large part of Canada's economy. Most of our
trade is with the United States, which is why
the value of our dollar against the U.S. dollar
is especially important.
Factors affecting the
exchange rate
Canada has a floating exchange
rate. That means there is no set value for our
currency compared with any other currency. The
exchange rate is affected by supply and demand
for Canadian dollars in international exchange
markets. If demand exceeds supply, the value of
the dollar will go up. If the supply exceeds
demand, its value will go down. On an average
day, CAN$100 billion is bought and sold on the
international exchange markets.
Several factors influence the supply of, and
demand for, Canadian dollars. If
interest rates are higher in Canada than in
other countries, investors may choose to invest
in Canada, increasing demand for the dollar,
provided that the expected rate of
inflation is not higher in Canada than among
our trading partners. If our inflation rate is
higher, investors are less likely to prefer
Canada—even with higher interest rates—because
of the expectation that the value of the dollar
will be eroded by inflation.
Our
trade balance also affects our dollar. If world
prices for what we export rise in comparison
with the cost of our imports, we will be earning
more for our exports than we pay for our
imports. The more favourable these "terms of
trade," the more demand there will be for the
Canadian dollar.
If investors are confident
that the Canadian economy will be strong, they
will be more likely to buy Canadian assets,
pushing up the dollar's value.
Monetary conditions
Together, interest rates and
the exchange rate determine the monetary
conditions in which the Canadian economy
operates. Changes in the exchange rate affect
spending and demand in the economy just as
changes to interest rates can either increase or
decrease the level of economic activity.
The Bank of Canada influences
the exchange rate only indirectly. This can
happen when the Bank changes its
Target for the Overnight Rate, which affects
short-term interest rates. As of September 1998,
the Bank no longer
intervenes in foreign exchange markets to
ensure an orderly market, but rather reserves
such actions for times of major international
crisis or a clear loss of confidence in the
currency or in Canadian dollar-denominated
securities.
