Transcript Stepen Poloz`s Addresses on International Finance for Canada

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-shouldget-used-to-lower-dollar-higher-inflation-Polozsays.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 the theory below, and indicate what is changing for the Canadian case:
Supply of FOREX
Trade Balance
Current Account
Financial Account
Above-the-Line BP
Balance
Changes in Official
FOREX Reserve
X
Capital Inflows
Demand for FOREX
M
Capital Outflows
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
dX/de – 1 – dM/de > 0
dX/de – dM/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).
 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
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/10.1162/00346530577509818
9
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 per person.”
What will happen to X-M in the longrun?

The prices faced by the International Buyers, say Americans, of Canadian goods may be:
𝑃 𝑐𝑎𝑛𝑎𝑑𝑎
𝑒
falls in short-run (as e rises in Canada)
𝑃 𝑐𝑎𝑛𝑎𝑑𝑎
may rise back in long-run with the presence of Pass-Though (from e up -> import prices up 𝑒
> Canadian domestic prices up)
Then, even in the long-run, X will not rise as much as expected by Mr. Poloz.
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/002219969190024Z/1-s2.0002219969190024Z-main.pdf?_tid=59637cf2-b82f-11e5-91a100000aab0f6c&acdnat=1452495100_b593fdeb5ab497420a3832
e40015fbf1
 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?