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The Exchange Rate and Canadian Inflation Targeting

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Abstract

The author provides a non-technical explanation of the role played by the exchange rate in Canada's inflation-targeting monetary policy. He reviews the motivation for inflation targeting and describes the monetary transmission mechanism. Though the exchange rate is an integral component of the transmission mechanism, the author explains why it is not a target for monetary policy. He provides a simple taxonomy for exchange rate movements, distinguishing between movements associated with direct shocks to aggregate demand and those unrelated to such direct shocks. He explains the importance to monetary policy of determining the cause of any given movement in the exchange rate, and of determining the net effect on aggregate demand. The author also describes Canadian monetary policy during the 2003-04 period, a time when the Canadian dollar appreciated sharply against the U.S. dollar.

Suggested Citation

  • Christopher Ragan, 2005. "The Exchange Rate and Canadian Inflation Targeting," Staff Working Papers 05-34, Bank of Canada.
    • Handle: RePEc:bca:bocawp:05-34
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    References listed on IDEAS

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    1. David Laidler & William B.P. Robson, 2004. "Two Percent Target: The Context, Theory, and Practice of Canadian Monetary Policy since 1991," C.D. Howe Institute Policy Studies, C.D. Howe Institute, number 20041, January.
    2. Dedola, Luca & Lippi, Francesco, 2005. "The monetary transmission mechanism: Evidence from the industries of five OECD countries," European Economic Review, Elsevier, vol. 49(6), pages 1543-1569, August.
    3. Willem H. Buiter & Douglas D. Purvis, 1980. "Oil, Disinflation, and Export Competitiveness: A Model of the "Dutch Disease"," NBER Working Papers 0592, National Bureau of Economic Research, Inc.
    4. Murray, John, 2000. "Why Canada needs a flexible exchange rate," The North American Journal of Economics and Finance, Elsevier, vol. 11(1), pages 41-60, August.
    5. Charles Freedman, 1995. "The role of monetary conditions and the monetary conditions index in the conduct of policy [speech]," Bank of Canada Review, Bank of Canada, vol. 1995(Autumn), pages 53-59.
    6. Lucio Sarno & Mark P. Taylor, 2002. "Purchasing Power Parity and the Real Exchange Rate," IMF Staff Papers, Palgrave Macmillan, vol. 49(1), pages 1-5.
    7. Jean Farès & Gabriel Srour, 2001. "The Monetary Transmission Mechanism at the Sectoral Level," Staff Working Papers 01-27, Bank of Canada.
    8. Tiff Macklem, 2001. "A New Measure of Core Inflation," Bank of Canada Review, Bank of Canada, vol. 2001(Autumn), pages 3-12.
    9. Robert Lafrance & Lawrence L. Schembri, 2002. "Purchasing-Power Parity: Definition, Measurement, and Interpretation," Bank of Canada Review, Bank of Canada, vol. 2002(Autumn), pages 27-33.
    10. Walter Engert & Jack Selody, 1998. "Uncertainty and Multiple Paradigms of the Transmission Mechanism," Staff Working Papers 98-7, Bank of Canada.
    11. Jiri Jonas & Frederic S. Mishkin, 2003. "Inflation Targeting in Transition Countries: Experience and Prospects," NBER Working Papers 9667, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Carlos García & Jorge Restrepo & Scott Roger, 2009. "Hybrid Inflation Targeting Regimes," Working Papers Central Bank of Chile 533, Central Bank of Chile.
    2. Kempa, Bernd & Riedel, Jana, 2013. "Nonlinearities in exchange rate determination in a small open economy: Some evidence for Canada," The North American Journal of Economics and Finance, Elsevier, vol. 24(C), pages 268-278.
    3. Garcia, Carlos J. & Restrepo, Jorge E. & Roger, Scott, 2011. "How much should inflation targeters care about the exchange rate?," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1590-1617.
    4. Delpachitra, Sarath & Hou, Keqiang & Cottrell, Simon, 2020. "The impact of oil price shocks in the Canadian economy: A structural investigation on an oil-exporting economy," Energy Economics, Elsevier, vol. 91(C).
    5. repec:zbw:bofrdp:2009_031 is not listed on IDEAS
    6. Laurence Ball, 2010. "Policy Responses to Exchange-rate Movements," Open Economies Review, Springer, vol. 21(2), pages 187-199, April.
    7. Stuart Landon & Constance Smith, 2010. "Government Revenue Volatility: The Case of Alberta, an Energy Dependent Economy," EERI Research Paper Series EERI_RP_2010_23, Economics and Econometrics Research Institute (EERI), Brussels.
    8. Martin T. Bohl & David G. Mayes & Pierre L. Siklos, 2011. "The Quality Of Monetary Policy And Inflation Performance: Globalization And Its Aftermath," Manchester School, University of Manchester, vol. 79(s1), pages 617-645, June.
    9. Thorsten V. Koeppl, 2009. "How Flexible Can Inflation Targeting Be? Suggestions for the Future of Canada's Targeting Regime," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 293, August.
    10. Stuart Landon & Constance Smith, 2010. "Energy Prices and Alberta Government Revenue Volatility," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 313, November.
    11. Martin T. Bohl & David G. Mayes & Pierre L. Siklos, 2011. "The Quality Of Monetary Policy And Inflation Performance: Globalization And Its Aftermath," Manchester School, University of Manchester, vol. 79(s1), pages 617-645, June.

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    More about this item

    Keywords

    Exchange rates; Inflation targets; Monetary policy implementation;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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