Abstract: This paper analyzes the relationship between Canadian Monetary Policy
and the movements of Canada's real and nominal exchange rates with
respect to the U.S. A broad-based theory is developed to form the basis
for subsequent empirical analysis. The main empirical result is that
the Canadian real exchange rate has been determined in large part by
capital movements into and out of Canada as compared to the U.S. and
world energy prices. Additional important determinants were world
commodity prices and Canadian and U.S. real GDPs and employment rates.
No evidence of effects of unanticipated money supply shocks on the nominal
and real exchange rates is found. Under conditions where exchange rate
overshooting is likely to occur in response to monetary demand or supply
shocks, this suggests that the Bank of Canada follows an orderly-markets
style of monetary policy and the conclusion is that this is the best
approach under normal conditions. Finally, it is shown that in response
to a domestic inflation rate that has become permanently too high or a
catastrophic situation in the U.S., the Bank of Canada can induce a
one-percent short-run change in the unemployment rate by pushing the
nominal and real exchange rates in the appropriate direction by between
five and six percent.
Keywords: Real Exchange Rate Canadian Monetary Policy
JEL Classification: A; E; F; G;