Last week, I posted about how several chartered-bank economists have been denying the Bank of Canadaâ€™s capacity to lower the Canadian dollar. While I think that the chartered banks generally prefer a high loonie, it is important to note that not all of their economists are signing from the same songbook.
CIBCâ€™s Avery Shenfeld advocates intervention by the Bank of Canada to lower the exchange rate. Yesterday, The Toronto StarÂ presented him and me as allies on this front. How likely is Mark Carney to act on our advice?
Last weekâ€™s Monetary Policy Report (MPR) did not give me much hope. The â€œPolicy Responseâ€ section following the â€œExchange Rateâ€ section (page 22) does not mention any future policy options. It simply touts interest rates already being near zero (a policy advanced here months before the Bank of Canada implemented it.)
The â€œExchange Rateâ€ section itself states, â€œWhile higher commodity prices have been supportive, movements in the Canadian dollar over the period appear to have been increasingly driven by a broader depreciation of the U.S. dollar against most major currencies.â€
Presenting a weaker American dollar as the main story is often intended to suggest that Canada cannot do anything about the exchange rate. (In fact, the loonie has risen far more than the greenback has fallen.)
The Globeâ€™s Kevin Carmichael offers a different interpretation of the same statement. He notes that, while the Bank of Canada accepts appreciation justified by higher commodity prices, it may be more likely to intervene against appreciation caused by financial flows away from the U.S. dollar.
On whether or not commodity prices justify the loonieâ€™s rise, the MPR makes the same point as I did a couple of years ago: Canada has a larger trade surplus in natural gas than in oil (Technical Box 1 on page 6). For Canadaâ€™s trade balance, natural-gas prices are more important than oil prices. While oil has rebounded, natural gas has slumped.
The MPR also sheds light on the effects of a higher Canadian dollar. The Bank of Canada changed its projection from an 87-cent dollar in July to a 96-cent dollar now. As a result, Canadian exports will be relatively harder to sell and imports will be relatively more attractive to Canadian consumers.
Specifically, a comparison of net-export figures (exports minus imports) suggests that a 10% increase in the exchange rate decreases annual economic growth by 0.2% (i.e. net exports from -0.8% to -1.0% for 2010 and +0.1% to -0.1% for 2011; see Table 3 on page 23).
My inference slightly understates this effect, because the elevated exchange rate also erased whatever small positive influence a generally stronger global outlook (today versus July) would otherwise have had on projected exports. Still, in the Bank of Canadaâ€™s assessment, a significantly higher Canadian dollar is hardly catastrophic.
Combining my reading of the MPR with rebroadcast portions of the post-MPR press conference leads me to conclude that, given an exchange rate around 96 American cents, Carney will not proactively lower it to accelerate growth and reach the inflation target a little sooner. However, if the Canadian dollar jumps much above 96 cents, Carney may react by bringing down the hammer of intervention.
Of course, a central bank could choose to be explicit about its exchange-rate policy. However, doing so would involve abandoning the cherished pretence that the Bank of Canada only regulates inflation.