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

An Anatomy of Governor Stephen Poloz’s

Speeches for Canadian International Finance

J.D. HanKing’s University College

at Western UniversityJanuary 10, 2016

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?

Key Points and their Analysis

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-on-business/economy/canadians-should-get-used-to-lower-dollar-higher

Listening to him and his commetators speaking:

 “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.

Worsening Canadian ‘Terms of Trade’

“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).

Weakness of Exports, and Canadian Dollars

Recall the theory below, and indicate what is changing for the Canadian case:

What else is contributing a Weak Canadian dollar?

Supply of FOREX Demand for FOREXTrade BalanceCurrent Account

X M

Financial Account Capital Inflows Capital Outflows

Above-the-Line BP Balance X+ KI – (M+KO)>0 BP Surplus

X+KI – (M+KO) = BP EquilibriumX+KI – (M+KO) <0 BP Deficits

Downward Pressures on FOREX rate Upward Pressures on FOREX rate

Changes in Official FOREX Reserve

Official Reserves DownOfficial Financial Inflows

Official Reserves UPOfficial 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?

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?

U.S. and Canadian Monetary Policies ‘Diverge’:

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.

* International Financial Theory of Determination of FOREX Rates

Not long.

**How long can Canadian monetary policy and interest rate diverge from U.S. MP and i?

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.

FOREX Rate has risen and will rise

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

Impacts of a Falling Canadian Dollar Value on the Canadian Economy

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.

Short-run Impacts of a Falling Canadian Dollar Value on the X-M

X – M is in fact X – e M, where e is FOREX rate.Differentiating both side by e, we get

dX/de – 1 – dM/de > 0

dX/de – dM/de > 1Intuitively, 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).

proof]

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).

dX/de may take longer than dM/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 get worse. (still, X-M will rise in the end if the Marshall Lerner condition works)X-M

Time

It may not be the case, though,

And “Pass-Through” InflationDomestic inflation rate = F(domestic excess demand pressure)+ G(world inflation rate + FOREX appreciation)

Increasing Payments for Imports may be the first thing to be felt.

Read Jose Campa and Linda Goldburg, “Exchange Rate Pass-through into Import Prices”, RES (2005).

http://www.mitpressjournals.org/doi/pdf/10.1162/003465305775098189 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?

Pass Through

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

The prices faced by the International Buyers, say Americans, of Canadian goods may be:

falls in short-run (as e rises in Canada)

may rise back in long-run with the presence of Pass-Though (from e up -> import prices up -> Canadian domestic prices up)

Then, even in the long-run, X will not rise as much as expected by Mr. Poloz.

What will happen to X-M in the long-run?

Andrew Rose, “Roles of FOREX rates…: Does ML condition work?”, JIE(1996)

http://ac.els-cdn.com/002219969190024Z/1-s2.0-002219969190024Z-main.pdf?_tid=59637cf2-b82f-11e5-91a1-00000aab0f6c&acdnat=1452495100_b593fdeb5ab497420a3832e40015fbf1

Andrew Rose, “Is there a J-curve?”, JME(1989)http://www.sciencedirect.com/science/article/pii/0304393289900160

Empirical works indicate that in the long-run,Exchange Rates and Trade Balance may not be

consistently related.

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?

Then, where would the Long-term Growth come in the Canadian economy?