The merits of a floating exchange rate

Deputy Governor Lawrence Schembri explains how Canada’s monetary policy framework—inflation targeting underpinned by a flexible exchange rate—has proved to be the most durable in the post-war period.

Watch Deputy Governor Schembri speak to the Economics Society of Northern Alberta. Read the full speech.

50 years of experience

Canada has had a floating exchange rate for longer than any other country. This approach has contributed to:

  • low and stable inflation
  • strong and sustainable output and employment growth
  • adjustments to fluctuations in commodity prices

Canada and many other countries, almost 40 in total, have been able to successfully chart an independent course for monetary policy and exert domestic control over inflation because of the leeway provided by a flexible exchange rate.”

Lawrence L. Schembri, Deputy Governor

The benefits of our floating dollar

Canada and many other open economies have been well served by a market-determined flexible exchange rate. The floating dollar has four main benefits.

Monetary policy independence

Open, trading economies like Canada’s are exposed to global economic storms. A flexible exchange rate gives us the flexibility to set our own course for monetary policy and inflation.

Adjustment to external shocks

Our dollar’s value is closely tied to the prices of oil and other commodities. And commodity prices are typically hit first in a shock, whether it is a global trade war or a recession in a key trading partner.

  • For example, many jobs were lost in energy-producing provinces during the oil price shock of 2014, but by allowing the dollar to drop in value along with the price of oil, many more jobs were created in manufacturing and other industries whose products were exported.
  • In fact, we estimate that 900,000 fewer jobs would have been created if the Bank had raised interest rates to support the dollar.

Policy clarity and effectiveness

Because monetary policy focuses exclusively on keeping prices low and stable, the role of the exchange rate has become clearer. It responds to external shocks, particularly commodity price movements.

Financial sector development

Canada’s flexible exchange rate has contributed to more choice in and better access to financial markets and institutions. This improvement in choice and access supports the free flow of capital and trade. It also ensures that interest rate decisions are transmitted throughout the economy more effectively.

Toward 2021: renewing Canada’s monetary policy framework

The Bank of Canada’s five-year inflation-control agreement with the Government of Canada has two components: a 2 per cent inflation target and a flexible exchange rate.

  • It is currently being reviewed to ensure that it best achieves our goal of price stability, which contributes to strong growth and job creation. It will be renewed in 2021.
  • As part of the review, we are engaging with academics and other central banks as well as a wide range of stakeholders and interested Canadians.

While we’re not going to alter the flexible exchange rate component of our monetary policy framework, it is incumbent on policy-makers to review even successful regimes regularly to ensure that they are serving the best interests of Canadians.”

Lawrence L. Schembri, Deputy Governor