Decoding Carney

Last week, I posted about how several chartered-bank economists have been denying the Bank of Canada’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.

CIBC’s Avery Shenfeld advocates intervention by the Bank of Canada to lower the exchange rate. Yesterday, The Toronto Star presented him and me as allies on this front. How likely is Mark Carney to act on our advice?

Last week’s Monetary Policy Report (MPR) did not give me much hope. The “Policy Response” section following the “Exchange Rate” 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 “Exchange Rate” section itself states, “While 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.”

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 Globe’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 loonie’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 Canada’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 Canada’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.

5 comments

  • You had me until pretence.

  • Erin, .96 is what Carney last said he thought fair value was. Revised up from .87. Why would he not just change his target again”? I think his inflation target is way more credible than his revised exchange rate target.
    —–
    SG:
    Writing *pretence* is always more welcome than being pretentious. More to the point, pretence is apt because your own gods demand that by definition regulating inflation is also regulating employment. Or are you now arguing that there is no connection between inflation and employment?

  • Carney lost credibility in his press conference when he defended the Cdn$ appreciation by quoting the Aussie$ and Brazilian R$ have also risen against the declining US$. Of course he had come prepared but the journalists weren’t. Interesting to note he picked Australian dollar, who doesn’t know the Downunder booming commodities trade with the Chinese, while Harper was picking his battles with………China. It should be noted the exports from Australia to China continued to rise in spite of snags in political relationship, while Canada put its trading relationship on the shelf. That shows the scope of damage done to the goodwill created by previous governments over decades and decades of hard work.. Australia also introduced a big fiscal stimulus early on and recently increased its interest rate to 3.25%.

    Brazil (population 200million) is a export economy with trade surplus growing in double digit multiples during this decade and interest rate above 8.5%. Besides Brazil shifted its biggest historic trading partnership with China from that with US and continues to forge stronger economic ties. Where is the comparison with Canadian currency appreciation? The press let him get away with his deflection.

    Not difficult to observe where is this all heading to. This saturday Globe &Mail published an article musing North American Monetary Union.

    http://www.theglobeandmail.com/news/opinions/putting-to-rest-a-too-vigorous-bird/article1336485/

    Americans are in panic, US$ losing its coveted reserve currency status and BRIC and other aligned countries have openly discussed petrotrade in non-US$. What better way to thwart that right in its tracks by forging monetary union with gas reserves and natural resources rich Canada. This near parity with greenback deserves much serious attention than has been given.

    Looks like someone in Canada had given a rosier economic picture to International Banks than what the figures suggested and loonie fell. Don’t Canadians usually complain about being taken in by US, well this time it was a reversal. Wonders will never cease!

  • Kelsey, go over to Worthwhile Canadian and read the quick dirty demolition of the the Globe article on monetary union. While monetary union with US is an bad idea it nonetheless gets traction at the globe form time time which reflects the continentalist vision of its owners. For them I suspect it is just a logical extension of the FTA.

  • thanks @travis. Yeah, Worthwhile Canadian has thrown whole lotta shoes deservedly at that piece of journalism. Keeping with the same theme, The Security and Prosperity Partnership of North America has become an archive site and is no longer updated.
    http://www.spp.gov/

    Australia raised interest rates for the second time and Brazil slapped a 2% tax rate on the carry trade to control the over-appreciation of Real

    Via Bloomberg

    * Brazil will impose taxes on purchases by foreign investors of real-denominated, fixed-income securities and on purchases of stocks, Finance Minister Guido Mantega said.
    * Foreign investor will pay a 2 percent tax when they enter the country to buy stocks or fixed-income securities.
    * The measures are being taken “to avoid an excess speculation in the stock market and in capital markets,” Mantega told reporters in Sao Paulo.

    Our award winner Finance Minister is opposed to capping bankers’ bonuses. Good thinking!

    See you at the bitter end ………… government.

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