An Anatomy of Governor Stephen Polozs Speeches for

An Anatomy of Governor Stephen Poloz’s Speeches for Canadian International Finance J. D. Han King’s University College at Western University January 10, 2016

Key Points and their Analysis Canada will continue to have weak International Demand for Resources and Exports. Canada cannot afford to raise Interest Rates. <- Why? -> What will be its effect on International Finance of Canada? Canadian dollar will continue to loose the value against FOREX. Falling value of Canadian dollar may provide cushioning to the worsening economy -> Under what conditions may this NOT be relied upon? Canadian Industrial Structure will change -> from ‘resource’ to ‘resourcefulness? How? And when?

Listening to him and his commetators speaking: http: //www. bnn. ca/News/2016/1/7/Canadians-should-get -used-to-lower-dollar-higher-inflation-Poloz-says. aspx http: //www. theglobeandmail. com/report-onbusiness/economy/canadians-should-get-used-to-lowerdollar-higher

Worsening Canadian ‘Terms of Trade’ “terms of trade” is the ratio of the prices a country receives for its exports to the prices it pays for its imports. A falling terms of trade, on the other hand, means less export revenues and more import payment, and thus less net income for the country overall. X-M is falling rapidly due to a falling oil export revenue.

Weakness of Exports, and Canadian Dollars “Canada’s economy is directly affected by what is happening in China, where a weaker appetite for resources is depressing prices for oil, coal, copper and many of the key commodities that dominate this country’s exports and investments. ” Close relationship between Oil Price, (Exports), (X-M), and Canadian Dollar’s External Value(against major currencies).

What else is contributing a Weak Canadian dollar? Recall theory below, and indicate what is changing for the Canadian case: Supply of FOREX Demand for FOREX Trade Balance Current Account X M Financial Account Capital Inflows Capital Outflows Above-the-Line BP Balance Changes in Official FOREX Reserve X+ KI – (M+KO)>0 BP Surplus X+KI – (M+KO) = BP Equilibrium X+KI – (M+KO) <0 BP Deficits Downward Pressures on FOREX rate Upward Pressures on FOREX rate Official Reserves Down Official Financial Inflows Official Reserves UP Official Financial Outflows Question: Use the table above and explain which factors contribute to the current depreciation of Canadian dollar. What government policies affect those factors?

U. S. and Canadian Monetary Policies ‘Diverge’: When U. S. interest rate is going up as QE for 2006 Financial Crisis has ended, Bank of Canada cannot afford to hike up interest rate due to concern for domestic investment and rapid falling exports. ->Poloz says that Canada may even go for negative interest rates. ->Impacts on our International Investment Inbound and Outbound? ->And the external value of Canadian dollars?

* International Financial Theory of Determination of FOREX Rates Tells us the relationship between Monetary Policy and FOREX rate: East Monetary Policy /Money Supply Up -> (real) Interest Rate Down : “Liquidity Effect” -> International Investor pulls out Capital from Canada to U. S. -> Capital/Financial Outflows -> Domestic Currency Demand falls and FOREX Demand rises -> Domestic Currency depreciates; FOREX appreciates Comments: -Does Money Supply Up leads to Interest Rate Down at all times? <- Inflation Expectations Effect says MS up leads to (nominal) i up as well. -> In the short-run, liquidity effect > expectations effect - We will cover this later.

**How long can Canadian monetary policy and interest rate diverge from U. S. MP and i? Not long.

FOREX Rate has risen and will rise The external value of our Canadian dollar has fallen, and will keep falling. Poloz hopes that this may help boost the domestic ______investment through _______ interest rates, and boost the international _______ through the Marshall Lerner condition.

Impacts of a Falling Canadian Dollar Value on the Canadian Economy Short-run -Exports and Imports -Employment, National Income in the short-run -Price; Inflation Long-run Impacts -Exports and Imports -Industry Structure and Productivities -Employment and National Incomes

Short-run Impacts of a Falling Canadian Dollar Value on the X-M Marshall Lerner Condition A depreciation of the domestic currency (when FOREX rate or ‘e’ goes up) may improve NX(Trade Balance) if Elasticity of Export + (absolute value of) Elasticity of Imports > 1.

proof] X – M is in fact X – e M, where e is FOREX rate. Differentiating both side by e, we get d. X/de – 1 – d. M/de > 0 d. X/de – d. M/de > 1 Intuitively, when ‘e’ goes up by 1%, the left side is the benefits (X up and M down); the right side is the cost (import price goes up by 1).

Mr. Poloz says that in Canada, the Marshall Lerner condition is met unlike some other country(such as U. S. )

Bank of Canada let FOREX rate go as the Market dictates because a cheaper Canadian dollar or a higher FOREX rate in Canada helps boost Exports (quantity) and reduce Imports (quantity).

d. X/de may take longer than d. M/de-> ‘J Curve”: While the additional burden due to changing FOREX rate is immediate, it will take time for X and M will take time to adjust-> Before X-M improves, it will X-M get worse. (still, X-M will rise in the end if the Marshall Lerner condition works) Time

It may not be the case, though,

Increasing Payments for Imports may be the first thing to be felt. And “Pass-Through” Inflation Domestic inflation rate = F(domestic excess demand pressure)+ G(world inflation rate + FOREX appreciation)

Pass Through Read Jose Campa and Linda Goldburg, “Exchange Rate Passthrough into Import Prices”, RES (2005). http: //www. mitpressjournals. org/doi/pdf/10. 1162/0034653057750981 89 1) What is the ratio of d% of Import Prices/ d% of FOREX rates for Canada for the short-term and the long-term respectively? 2) If the exchange rate changes by 35% in the Canadian economy, what will be the change in import prices in the short-run?

“The cost to the country’s economy is $50 -billion a year or $1, 500 person. ”

What will happen to X-M in the longrun?

Empirical works indicate that in the long-run, Exchange Rates and Trade Balance may not be consistently related. Andrew Rose, “Roles of FOREX rates…: Does ML condition work? ”, JIE(1996) http: //ac. els-cdn. com/002219969190024 Z/1 -s 2. 0002219969190024 Z-main. pdf? _tid=59637 cf 2 -b 82 f-11 e 5 -91 a 100000 aab 0 f 6 c&acdnat=1452495100_b 593 fdeb 5 ab 497420 a 3832 e 40015 fbf 1 Andrew Rose, “Is there a J-curve? ”, JME(1989) http: //www. sciencedirect. com/science/article/pii/030439328990 0160

Then, where would the Long-term Growth come in the Canadian economy? A falling Canadian dollar value may be a ‘shot in the arm’. Usually, a shot in the arm hampers efforts for an arduous search for Long-term Change. How can a falling Canadian dollar with a low interest rate lead to a rebuilding of the Canadian economy? What did he say?