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Why Canada Needs a Flexible Exchange Rate

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  • Murray, John
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    Abstract

    Increased interest has been shown in recent months regarding the feasibility and potential advantages of a common currency for Canada and the United States. This paper explores the arguments for and against such an arrangement and attempts to determine whether it would offer any significant advantages for Canada compared with the present flexible exchange rate system. The paper first reviews the theoretical arguments advanced in the economics literature in support of fixed and flexible currency arrangements. A discussion of Canada's past experience with the two exchange rate systems follows, after which there is a survey of the empirical evidence published on Canada's current and prospective suitability for some form of fixed currency arrangement with the United States. The final section of the paper examines critically a number of concerns raised about the behaviour of the current flexible exchange rate system. These concerns include its susceptibility to destabilizing speculation; the depressing effect it might have on trade and investment flows; the encouragement it might provide for lax fiscal policies; and the harmful effect it might have on productivity. On the basis of the evidence reviewed in this paper, the author concludes (i) that most of these concerns are either exaggerated or unsubstantiated; and (ii) that a flexible exchange rate continues to offer important advantages for Canada, given the significant differences that distinguish the Canadian and U.S. economies and Canadians’ desire for policy independence.

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    File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/05/wp99-12.pdf
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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 99-12.

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    Length: 33 pages
    Date of creation: 1999
    Date of revision:
    Handle: RePEc:bca:bocawp:99-12

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    Keywords: Exchange rates;

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    Cited by:
    1. Devereux, Michael B, 2001. "International Risk-Sharing and the Exchange Rate: Re-evaluating the Case for Flexible Exchange Rates," CEPR Discussion Papers 2900, C.E.P.R. Discussion Papers.
    2. George M. von Furstenberg, 2005. "Mexico versus Canada: Stability Benefits from Making Common Currency with USD?," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 10(2), pages 15-37, Summer.
    3. Grubel, Herbert G., 2000. "The merit of a Canada-US monetary union," The North American Journal of Economics and Finance, Elsevier, vol. 11(1), pages 19-40, August.
    4. Jeff M. Rogers & Pierre Siklos, 2001. "Foreign Exchange Market Intervention in Two Small Open Economies: The Canadian and Australian Experience," Research Paper Series 57, Quantitative Finance Research Centre, University of Technology, Sydney.
    5. Lafrance, Robert & St-Amant, Pierre, 2000. "Les zones monétaires optimales," L'Actualité Economique, Société Canadienne de Science Economique, vol. 76(4), pages 577-612, décembre.
    6. Liliane Karlinger, 2002. "The Impact of Common Currencies on Financial Markets: A Literature Review and Evidence from the Euro Area," Working Papers 02-35, Bank of Canada.
    7. Mejia-Reyes, P., 2004. "Classical Business Cycles in America: Are National Business Cycles Synchronised?," International Journal of Applied Econometrics and Quantitative Studies, Euro-American Association of Economic Development, vol. 1(3), pages 75-102.
    8. Nils Björksten & Arthur Grimes & Özer Karagedikli & Christopher Plantier, 2004. "What can the Taylor rule tell us about a currency union between New Zealand and Australia?," Reserve Bank of New Zealand Discussion Paper Series DP 2004/05, Reserve Bank of New Zealand.
    9. Sharon McCaw & C John McDermott, 2000. "How New Zealand adjusts to macroeconomic shocks: implications for joining a currency area," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 63, March.
    10. David Hargreaves & Elizabeth Watson, 2011. "Sudden stops, external debt and the exchange rate," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 74, pages 1-11, December.
    11. John Murray & James Powell, 2002. "Dollarization in Canada: The Buck Stops There," Technical Reports 90, Bank of Canada.

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