Exchange Rate and International Trade

1
Exchange Rate and International Trade

• Michael C. McCracken
• Informetrica Limited
• 8 October 2003
• Senate Finance Committee

2
What Do We Know?

• Exchange Rate changes will affect
• Export Prices
• Import Prices
• Changes take time
• Other prices will also change
• Real responses may occur
• Total effects must consider why the exchange rate
  changed initially

3
Other Considerations

• What kind of monetary policy rule is in place?
• How persistent is the exchange rate change
  expected to be?
• Does the economic system behave similarly to
  appreciation and depreciation?
• Large changes and small changes?

4
Why this Question Now?

• Table showing exchange rate changes since 1990
• Depreciation through 2002
• Recent appreciation
• Concern about US pressure for us (and China) to
  appreciate
• Weakness in Canadian manufacturing and resources
  help from a lower dollar?

5
Exchange rate changes
6
Interconnected system
Canadian Economy
CAN/USExchange Rate
US Economy
CanadianPolicies
7
20 appreciation

• Export import commodity prices 20 decline
  quickly
• Other export and import prices decline of
  10-15 over several years
• Corporate profits down relatively
• CPI lower, import-competing prices down
• Wage increases moderate
• ME prices down

8
Real effects

• Real wages up
• Real disposable income and consumption up
• Real imports up
• Real exports ?
• US prices for Canadian goods higher (-)
• US depreciation positive for industry demand ()
• Investment ?

9
Other Macro Indicators

• Inflation lower
• Interest rates lower
• Current account balance weakens
• Real GDP - ?
• Unemployment - ?
• Government balances federal down, provincial up

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What is happening?

• Story I US depreciation against all major
  currencies, with Canada following but less so.
  Net result is Canada appreciates versus US
  (Sideswipe)
• Story II Fundamentals in Canada are wonderful
  and finally coming through in exchange rate
• Story III Special Factors

11
Why a US depreciation?

• Unsustainable Current Account?
• Interest rates low
• Increased international frictions lessen desire
  to hold US assets
• California governance concern?

12
Why a Canadian appreciation?

• Relative inflation performance
• Higher Canadian interest rates
• Expected growth higher
• Commodity prices expected up
• Current Account and Long-term capital flow
  balance relatively stronger than US

13
Special Factors

• Quebec separation threat less
• New opportunities
• Lower Churchill
• Alaska Highway Gas Pipeline
• BC gas discoveries
• New PM?
• Reversal of negatives
• SARS over, mad cow no more, Blackout not
  Canadian origin

14
Canadian policy directions

• Lower interest rates
• Encourage investment
• Expand export opportunities
• Follow-up on expanding opportunities
• Encourage employment
• Fiscal dividends from lower inflation and lower
  interest rates will help provincial governments