International Financial Crises and Flexible Exchange Rates: Some Policy Lessons from Canada
AbstractThis paper examines the behaviour of the Canadian dollar from 1997 to 1999 to see if there is any evidence of excess volatility or significant overshooting. A small econometric model of the exchange rate, based on market fundamentals, is presented and used to make tentative judgments about the extent to which the currency might have been systematically over- or undervalued. Three major conclusions emerge from the analysis. First, movements in world commodity prices and Canada-U.S. interest rate differentials can account for most of the observed variation in the value of the Canadian dollar. Any deviations that were recorded between actual and predicted values of the exchange rate were generally small and short-lived, suggesting that destabilizing speculative behaviour did not play a very important role in recent market developments. Second, while it is possible to explain most of the past movements in the Canadian dollar using a simple exchange rate equation, its ability to predict future movements in the exchange rate is limited due to the inherent instability of the fundamental variables guiding its behaviour. Exchange rate predictions, in short, are only as accurate as the forecasts of future commodity prices and interest rates. Third, it appears that periods of market turbulence are often dominated by fundamentalists as opposed to noise traders and are triggered typically by large external shocks. Monetary authorities should therefore be wary of resisting any movements in the exchange rate, since they are often part of a necessary and unavoidable adjustment process. Aggressive foreign exchange market intervention and other monetary policy actions designed to stabilize the exchange rate could easily prove counterproductive and subvert market efficiency.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Bank of Canada in its series Technical Reports with number 88.
Length: 44 pages
Date of creation: 2000
Date of revision:
Contact details of provider:
Postal: 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/
Exchange rates; Exchange rate regimes;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Vigfusson, R., 1996.
"Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach,"
96-1, Bank of Canada.
- Vigfusson, Robert, 1997. "Switching between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 2(4), pages 291-305, October.
- Robert Vigfusson, 1996. "Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach," International Finance 9602003, EconWPA.
- Murray, J. & Van Norden, S. & Vigfusson, R., 1996. "Excess Volatility and Speculative Bubbles in the Canadian Dollar: Real of Imagined?," Technical Reports 76, Bank of Canada.
- Rudiger Dornbusch, 1979.
"Monetary Policy Under Exchange Rate Flexibility,"
NBER Working Papers
0311, National Bureau of Economic Research, Inc.
- Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
- St-Amant, P. & Tessier, D., 1998. "Tendance des dépenses publiques et de l'inflation et évolution comparative du taux de chômage au Canada et aux États-Unis," Working Papers 98-3, Bank of Canada.
- Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
- Muller, P. & M. Zelmer, 1999. "Greater Transparency in Monetary Policy: Impact on Financial Markets," Technical Reports 86, Bank of Canada.
- B. Moazzami & F. J. Anderson, 2003. "Long-term trend and short-run dynamics of the Canadian dollar: an error correction modelling approach," Applied Economics, Taylor and Francis Journals, vol. 35(13), pages 1527-1530.
- Jamie Armour & Ben Fung & Dinah Maclean, 2002. "Taylor Rules in the Quarterly Projection Model," Working Papers 02-1, Bank of Canada.
- Toni Gravelle & Richhild Moessner, 2001. "Reactions of Canadian Interest Rates to Macroeconomic Announcements: Implications for Monetary Policy Transparency," Working Papers 01-5, Bank of Canada.
- repec:ner:dauphi:urn:hdl:123456789/10086 is not listed on IDEAS
- Marie Bessec & François-Mathieu Robineau, 2003.
"Comportements chartistes et fondamentalistes. Coexistence ou domination alternative sur le marché des changes?,"
Presses de Sciences-Po, vol. 54(6), pages 1213-1238.
- Celine Gauthier & David Tessier, 2002. "Supply Shocks and Real Exchange Rate Dynamics: Canadian Evidence," Working Papers 02-31, Bank of Canada.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.