Inflation On Target; Exchange Rate Off Target

Today, Statistics Canada reported an annual inflation rate of 2%, precisely in line with the Bank of Canada’s target. With inflation under control and renewed risks to the global economy, there is little rationale for the central bank to raise interest rates anytime soon.

In fact, the Bank of Canada should now be more concerned about the exchange rate than the inflation rate. Recent debate about Dutch disease highlights the Canadian dollar’s overvaluation.

While the loonie trades for about 98 U.S. cents on financial markets, the OECD calculates that its real purchasing power is equivalent to only 76 U.S. cents. This discrepancy hurts manufacturing and other industries that export output abroad, but buy inputs in Canada.

An interest-rate hike would aggravate this problem by driving up the exchange rate. On the contrary, the Bank of Canada should help alleviate Dutch disease by intervening in foreign-exchange markets to moderate the loonie to more competitive levels. (Directly managing their exchange rate is, in fact, how the Dutch cured Dutch disease.)

Wages vs. Inflation

The national average hourly wage rose by 2.3%, slightly more than inflation. However, Ontario’s provincial inflation rate of 2.1% is triple the average Ontario wage increase of 0.7%.

UPDATE (May 19): Quoted in The Hamilton Spectator and St. John’s Telegram

3 comments

  • Hi Erin,
    I can’t really agree with Bank of Canada intervention in currency markets to lower our dollar under current circumstances. The dollar is clearly over-valued due to its association with resources, especially oil. Lowering its value will greatly increase profitability of resource industries since their costs will drop by the amount of the devaluation. The result will be further over-expansion of these industries. So we’ll wind up buying vast quantities of US dollars to keep our dollar low but set up a dynamic for an indefinite increase in these purchases until resource prices drop significantly for some reason.The Dutch only had oil. We have much much more.
    The best way to deal with this is to rein in the oil and gas industry by taking over part of it and redirecting it into public interest ownership and/or by applying our existing environmental laws. If these are impossible to do we could lower foreign ownership which would happen by itself in any case if either of the two previous measures were instituted.

  • I do not agree with intervention for our currency due to factors being escalated by the American and Chinese central banks. Canadians should not give up their monetary policy to buy and hold US dollars. This strategy wont prevent the US dollar from weakening further either requiring further action by the central bank of Canada.

    These low interest rates you, & others cheered for have produced Canadians borrowing at very low rate for housing, which they can afford now, but will not when rates reset. Canadian simply with assets are borrowing vast sums of cash to be used on consumption. Houses used as ATMs is not good for the economy, or all Canadians.

    The longer Candian borrow at low rates for housing, total real estate debt will go up, and eventually the mortgage payments too, will increase, draining disosable income. Adjust for inflaition because housing prices are out of whack with Canadian incomes.

    I cannot justify economically 20-40 year olds borrowing 300k for a house, with student debt to boot, probably some credit card debt, that due to rising prices without matching wages, and likly increasing morgagte payments will lead to anything but unemployment when he has no disposable income to spend.

    The top1% are concentrating more wealth comparable with other times in history, increasing prices without correspondng growth in wages at the bottom, have enriched them even further. Any inflation without matching wages is irresponsible, wrong, and should be fought with every inch of the soul.

    There is currently no regulation in place or was enforced to stop this. Progressive wishing to unwind thiss mess caused by low rate of interest will require new or existing law that is unhindered, then have strictly enforced, and then see if it works for Canadian of all colors, or you could use the crude but effective interest rate policy as Paul Vockler the last defender of Glass Steagall Act, who hiked the rate to 20%.

    I was never an adovocate for these low borrowing costs, that in my opinion have created a huge burden that should have never existed, we wasted resources, time, energy to become builders of houses we wont need in comparison to products, services, we need daily given what collasped in the US.

    “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.”

    “This excerpt from The Economic Consequences of the Peace, written just at the end of World War I, makes clear how fully he understood inflation’s potential to destroy the fabric of society.”

    Please Progressives dont be “too short-sighted” in printing money, balance your book, either from taxes, loans. Dont print money.

  • There are ways to limit mortgage lending without hiking interest rates.

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