The Bank of Canada should resist calls to fight the appreciation of the Canadian dollar against the U.S. greenback, according to a report released today by the C.D. Howe Institute.

The authors of the report, Yvan Guillemette, David Laidler and William Robson of argue that altering Canadian monetary policy in not the answer.

“The immediate causes of the dollar’s rise are buoyant world demand for Canadian exports, and the general depreciation of the U.S. dollar against all major floating currencies, likely caused by mounting concern over U.S. fiscal and current account deficits. Altering Canadian monetary policy, or even Canada’s monetary regime, would not ease the stress this is causing,” they say. “Worse, a focus on monetary responses to the strong currency could distract attention from reforms to Canadian tax, industrial and regional policies that would enhance the economy’s capacity to withstand currency volatility.”

Their report maintains that there’s no free lunch in having a weak currency. “If the currency were not free to rise and fall, the same fundamental forces that are now partly absorbed by the Canada-U.S. dollar exchange rate would create additional volatility in domestic output, employment and inflation instead,” the authors point out. If the Bank did cut rates to lower the dollar, they note that the country would soon face inflation, and the central bank would loose its hard-won credibility as a force against inflation.

Medium-term swings in the Canada-U.S. exchange rate result from differences in the structures of the two economies, the authors say say. Canada is a major exporter of commodities, and the U.S. is an importer. They argue the Canadian dollar is “still largely a commodity currency, and it will likely remain one in the foreseeable future”.

“Its recent rise is in part the consequence of catching up to the fundamentals of a commodity boom and, in recent months, a weakening U.S. dollar against all major currencies,” they add.

“Economic restructuring is a sustained process and Canada should make handling it easier. This does not require a different exchange rate policy; it calls for a set of tax and industrial policies that promote faster productivity growth throughout the economy,” they conclude. “That would cushion the impact of a volatile dollar on the sectors most exposed to it and, more broadly, would help provide the faster output growth that makes all economic adjustments easier.”