Fact Sheets
The Exchange Rate
THE EXCHANGE RATE REFERS to the value of the Canadian dollar against the
currencies of other countries. Among other things, it helps determine how much
we pay for imported goods and services and how much we receive for what we
export.
When the value of the Canadian dollar falls, imported goods become more
expensive, and we tend to reduce the volume of our imports. At the same time,
other countries will pay less for some of our products and that will tend to
boost export sales.
The exchange rate plays a particularly important role in our economy because,
compared with other countries, imports and exports are a relatively large part
of Canada's economy. Most of our trade is with the United States, which is why
the value of our dollar against the U.S. dollar is especially important.
Factors affecting the exchange rate
Canada has a floating exchange rate. That means there is no set value for our
currency compared with any other currency. The exchange rate is affected by
supply and demand for Canadian dollars in international exchange markets. If
demand exceeds supply, the value of the dollar will go up. If the supply exceeds
demand, its value will go down. On an average day, CAN$52 billion is bought and
sold on the international exchange markets.
Several factors influence the supply of, and demand for, Canadian dollars. If
interest rates are higher in Canada than in other countries, investors may choose to
invest in Canada, increasing demand for the dollar, provided that the expected
rate of inflation is not higher in Canada than among our trading partners. If our inflation rate is
higher, investors are less likely to prefer Canada even with higher interest
rates because of the expectation that the value of the dollar will be eroded by
inflation.
Our trade balance also affects our dollar. If world prices for what we export
rise in comparison with the cost of our imports, we will be earning more for our
exports than we pay for our imports. The more favourable these "terms of trade,"
the more demand there will be for the Canadian dollar.
If investors are confident that the Canadian economy will be strong, they
will be more likely to buy Canadian assets, pushing up the dollar's value.
Monetary conditions
Together, interest rates and the exchange rate determine the monetary
conditions in which the Canadian economy operates. Changes in the exchange rate
affect spending and demand in the economy just as changes to interest rates can
either increase or decrease the level of economic activity.
The Bank of Canada influences the exchange rate only indirectly. This can
happen when the Bank changes its Target for the Overnight Rate, which affects short-term interest rates. As of September
1998, the Bank no longer intervenes in
foreign exchange markets to ensure an orderly market, but rather reserves such
actions for times of major international crisis or a clear loss of confidence in
the currency or in Canadian dollar-denominated securities.
Last update : October 2003
Source: Bank of Canada