The idea of a fixed Canada-U.S. dollar exchange rate is as bad as ever, says economist David Laidler in an analysis from the C.D. Howe Institute.
Despite renewed interest in fixing the rate in recent months — alongside provincial concerns about the high dollar — Laidler, a fellow-in-residence at the institute, says Canada’s floating exchange rate does not move around gratuitously, but responds to economic influences that would persist even if the rate were pegged.
In “Fixing the Exchange Rate: Still a Bad Idea”, he warns it could easily result in larger swings in inflation and unemployment.
Laidler notes that movements in Canada’s exchange rate mostly can be explained by international demand for commodities. When markets for commodities boom, foreign buyers purchase Canadian dollars to pay for them and, under a floating exchange rate, bid up the loonie’s price.
If the exchange rate were fixed, the Bank of Canada would need to create more Canadian dollars for sale on the foreign market, he explains. Once issued, those dollars would enter domestic circulation, creating inflationary pressure and forcing the domestic inflation rate above the 2% target to which Canadians have become accustomed. And when commodity prices fall again, a fixed rate would need high interest rates to defend it.
Laidler states that progress in creating a single domestic market for goods and labour, reducing disincentives to investment in manufacturing and elsewhere, and enhancing the labour force’s skills and flexibility, will result in policies that make it easier to cope with pressure from world commodity markets.