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The Progressive Economics Forum

The Loonie’s Stagnant Purchasing Power

The following note also appears on Business Insider. I owe Paul Tulloch a hat tip for reminding me of these issues in a good comment on my last post.

When Ontario’s Premier recently complained that Canada’s petro-dollar undermines manufacturing exports, many economists tripped over each other to counter that a strong loonie benefits all Canadians through cheaper imports.

In theory, that makes sense. Incomes denominated in Canadian dollars should be worth more if each Canadian dollar buys more.

But it’s not a theoretical question. The Organisation for Economic Co-operation and Development (OECD) measures the purchasing power of currencies in member countries.

The Exchange Rate vs. Purchasing Power Parity
(annual averages in U.S. cents)

Year E-Rate PPP
2002 63.7 81.3
2003 71.4 81.5
2004 76.8 81.2
2005 82.5 82.4
2006 88.2 82.8
2007 93.0 82.6
2008 93.8 81.0
2009 87.6 83.5
2010 97.1 82.0
2011 101.1 81.3

 

The loonie has taken flight in financial markets, soaring from an annual average of 63.7 American cents in 2002 to 101.1 American cents in 2011.

Yet the OECD calculates that, in 2011, a Canadian dollar bought only as much in Canada as 81.3 American cents bought in the U.S. Strikingly, that ratio was exactly the same back in 2002. In other words, the loonie’s ascent has delivered no apparent improvement in purchasing power.

When the Canadian dollar reached parity with the U.S. dollar in 2007, many commentators cautioned that it could take time for the savings to be passed through to Canadian consumers. However, the loonie has now been near parity for four of the past five years.

Having Canada’s exports priced at this less competitive exchange rate has pushed many exporters out of business or out of the country. Canadians have lost more than half a million manufacturing jobs since 2002, but are still waiting for the promised benefits of a high-flying loonie.

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Comments

Comment from Travis Fast
Time: March 7, 2012, 9:13 pm

At least we get cheap pump prices for gas like the Saudis in reward for our resource client state status.

http://www.tradingeconomics.com/saudi-arabia/pump-price-for-gasoline-us-dollar-per-liter-wb-data.html

Comment from Andrew Jackson
Time: March 8, 2012, 8:46 am

This seems to imply that there has been no positive terms of trade effect on Canadian incomes, which is going a tad too far. The surprise is that the purchasing power of the Canadian dollar has remained unchanged against the US dollar despite much slower productivity growth.

Comment from Purple Library Guy
Time: March 8, 2012, 3:17 pm

You’d think with free trade there’d be some arbitrage opportunities there.

Comment from Erin Weir
Time: March 8, 2012, 7:16 pm

Purchasing power parity (PPP) includes non-tradable goods and services, for which prices reflect domestic factors such as productivity.

The specific measure cited above, PPP for GDP, also includes imported consumer and capital goods.

Therefore, it seems remarkable that a 60% appreciation in the exchange rate produced no appreciation at all in PPP.

Comment from Bruce Roberts
Time: March 9, 2012, 12:17 pm

This post is making an apple to oranges comparison. Changes in PPP result from changes in relative price levels in the Canada and the US. A constant PPP means that, over the period in question, inflation rates in Canada and the US have been the same on average.

This has little to do with purchasing power of the Canadian dollar which depends much more on the exchange rate. Over time the appreciation of the Canadian dollar has reduced the price paid for goods from the US (although that may not get passed on to consumers).

The argument made in the post would also lead to a conclusion that or manufacturers have not been hurt by the appreciating Canadian dollar.

Comment from Erin Weir
Time: March 9, 2012, 1:04 pm

I agree that a constant PPP means that inflation has been the same on both sides of the border. But if the rising exchange rate had been passed through to consumers, inflation would have been lower in Canada and PPP would have increased.

That’s my point: the loonie’s massive appreciation does not seem to have improved the purchasing power of Canadian consumers.

Perhaps the stronger currency has allowed the Bank of Canada to pursue more accommodative monetary policy than otherwise would have been required to keep inflation at 2%. If so, the benefit has been lower interest rates rather than lower prices.

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