This paper examines the factors that contributed to the rise in the Canadian dollar in 2003.
Economic theory and empirical evidence have identified a number of factors known to affect movements in exchange rates. In general, the value of the Canadian dollar relative to the US dollar is influenced by two distinct categories of catalyst.
Perhaps the most significant domestic influence on the Canadian dollar is the relative health of the Canadian economy.
The difference between interest rates in Canada and the United States is also a major determinant of the exchange rate between the two currencies.
Differences in inflation rates between Canada and the United States also affect currency movements in the long term. The current account measures the flow of goods, services and investment income between Canada and the rest of the world. A current account surplus means that since Canada is selling more than it is buying, there is a net flow of money into Canada.
Because Canada is a large producer and net exporter of resource-based goods, the Canadian dollar is often referred to as a commodity-based currency. That the rise in the Canadian dollar is in large part a US-based phenomenon is evident in the fact that the Canadian dollar is not the only currency to have appreciated against the US dollar since 2002. The significant difference between the performance of these (and other) currencies and that of the Canadian dollar is the period in which the bulk of the currency appreciation took place. Energy prices have been considerably more volatile than non-energy commodity prices, but they too are having an impact on the Canadian dollar. Moreover, some believe that the influence of energy prices on the Canadian dollar is increasing as Canada continues to grow as a producer and exporter of energy. As a member of the International Monetary Fund (IMF), Canada was committed to the Bretton Woods system of fixed exchange rates. In this report, the exchange rate refers to the cost, in Canadian dollars, of buying a unit of foreign currency. The Canadian dollar would, in all likelihood, rise against the currencies of other slower growing economies. As stated earlier, however, economic growth differentials between Canada and the United States also affect the value of the Canadian dollar.
PPP is an attempt to calculate the exchange rate which results in equal buying power for each currency. The Loonie-Dollar changes reflect the accumulated differential of monetary policy between the US Fed and the Bank of Canada over the last few years.
That decision was made in response to growing concerns about inflationary pressures in Canada and a rising level of foreign indebtedness. Indeed, economic indicators had pointed toward a higher Canadian dollar for a number of years before its eventual rise. Looking at monthly averages since 1990, the Canadian dollar has ranged from a low of 62 cents in February 2002 to a high of $1.04 in July 2011 with the average over the 22 year period being 79 cents.
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