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Why Canada Needs a Flexible Exchange Rate


  • Murray, John


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.

Suggested Citation

  • Murray, John, 1999. "Why Canada Needs a Flexible Exchange Rate," Staff Working Papers 99-12, Bank of Canada.
  • Handle: RePEc:bca:bocawp:99-12

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    References listed on IDEAS

    1. Marco Pagano, 1989. "Trading Volume and Asset Liquidity," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 255-274.
    2. Michael J. Fleming & Eli M. Remolona, 1997. "Price formation and liquidity in the U.S. Treasury market: evidence from intraday patterns around announcements," Staff Reports 27, Federal Reserve Bank of New York.
    3. Mark D. Flood Ronald Huisman Kees G. Koedijk and Richard Lyons., 1998. "Search Costs: The Neglected Spread Component," Research Program in Finance Working Papers RPF-285, University of California at Berkeley.
    4. Robert F. Engle & Joe Lange, 1997. "Measuring, Forecasting and Explaining Time Varying Liquidity in the Stock Market," NBER Working Papers 6129, National Bureau of Economic Research, Inc.
    5. Gravelle, Toni, 1998. "Buying Back Government Bonds: Mechanics and Other Considerations," Staff Working Papers 98-9, Bank of Canada.
    6. John Board & Charles Sutcliffe, 1996. "Trade Transparency and the London Stock Exchange," European Financial Management, European Financial Management Association, vol. 2(3), pages 355-365.
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    Cited by:

    1. 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.
    2. Liliane Karlinger, 2002. "The Impact of Common Currencies on Financial Markets: A Literature Review and Evidence from the Euro Area," Staff Working Papers 02-35, Bank of Canada.
    3. John Murray & James Powell, 2002. "Dollarization in Canada: The Buck Stops There," Technical Reports 90, Bank of Canada.
    4. Rogers, J. M. & Siklos, P. L., 2003. "Foreign exchange market intervention in two small open economies: the Canadian and Australian experience," Journal of International Money and Finance, Elsevier, vol. 22(3), pages 393-416, June.
    5. Michael B. Devereux, 2001. "International Risk-Sharing and the Exchange Rate: Re-evaluating the Case for Flexible Exchange Rates," Working Papers 122001, Hong Kong Institute for Monetary Research.
    6. Richard Carew & Wojciech J. Florkowski, 2003. "Pricing to Market Behavior by Canadian and U.S. Agri-food Exporters: Evidence from Wheat, Pulse and Apples," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 51(2), pages 139-159, July.
    7. von Furstenberg, George M., 2006. "Mexico versus Canada: Stability benefits from making common currency with USD?," The North American Journal of Economics and Finance, Elsevier, vol. 17(1), pages 65-78, March.
    8. 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.
    9. 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.
    10. 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.
    11. 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.
    12. 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.

    More about this item


    Exchange rates;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange


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