factors that affect the value of the canadian dollar

Factors that affect the value of the Canadian Dollar

Introduction:

There are various factors that contribute toward influencing the exchange rates. The appreciation or depreciation of a particular currency is not the result of a single factor i.e. factors influencing the exchange rates do not function in segregation but an intricate complex of these factors operates. Some of these factors are explicit whereas others operate latently but play important role in moulding the exchange rates of a particular currency.

Some economists are of the view that almost each change and disturbance in the domestic and global economic and political scenario casts its effect on the exchange rates. However Economists has identified certain specific factors that overtly influence the exchange rate of a particular currency i.e. economic robustness of the country, its socio-political situations, its fiscal and trade deficits, interest and inflation rates, political stability etc.

Canadian Dollar: Fluctuating Currency:

            “The exchange rate is arguably the most important asset price in a small open economy like Canada….” (Murray, Norden and Vigfusson. 1996. p. 2) But Canadian Dollar is often labelled as a fluctuating currency (Katz, 1953)[1]. This flux in the Canadian Dollar exchange rate as compared with U.S. Dollar is well indicated by Murray, Norden and Vigfusson (1996). Their study manifests that over a period of 25 years (1970-1995), Canadian Dollar has moved thin a range of approximately 35 cents (U.S), reaching a post war high of U.S. $ 1.04 on 25 April, 1974 and an all-time low of 69.5 cents (U.S) on 4 February 1984.” (p. 5) Canadian dollar is always weighed against the U.S. dollar due to the reason that United States is the largest trade partner of Canada. Now let’s look into the factors that affect the fluctuations in the exchange rate of Canadian Dollar.

Factors that Influence the Exchange Rate of Canadian Dollar:

Economic Stability and Trade Balance:

The vigour and robustness of Canadian economy is the foremost factor that manipulates Canadian Dollar. The macroeconomic indicators of Canadian economy indicate its strength and its steady growth rate. So these features of the Canadian economic milieu attract investors due to its prospective economic returns. So law of supply and demand necessitate an increased demand for Canadian Dollars. This raised demand elevates the exchange rate of Canadian Dollar in the international market. In vice versa to this situation a weak Canadian economy does not captivate the attention of the investors and demand for Canadian dollars remains limited. But factual reality shows that despite the strength of Canadian economy, sometimes its Dollar exchange rates falls as compared with other global currencies. As indicated earlier that only a single factor does not contribute toward influencing the appreciation of exchange rate. Another reason for this depreciation is that strength of an economy is not manifested only through a steady growth rate but trade balance between imports and exports also contribute toward it.

Commodity Prices:

As Canada is a manufacturer and exporter of resource-based products[2]. So a high demand for these products calls for Canadian Dollar and gains this demands increases the rate of exchange. This is the reason that Canadian Dollar is labelled as “commodity-based currency”. But there are two more reasons that enable the Canadian Dollar to fluctuate. Firstly, increase in the product prices at the international level will make the Canadian industry more lucrative capacitating it to attract more investors and pushing the Canadian dollar upward. But secondly cost effectiveness impedes the way as if the value of Canadian Dollar rises then it impinges on market competitiveness of traders and cost effectiveness of Canadian goods. This rise in the value of dollar results in the sharp decline of exports.

Interest Rate:

Another important factor is the interest rate as it captivates the investors for short term. Canada high interests and less intervention by Bank of Canada[3] in the interest rates has made Canada a more lucrative economy for short term investment. Some economists are of the view that higher interest rate will force the Bank of Canada to fix the exchange rates of Canadian Dollar as any  appreciation of Canadian Dollar leads more payments payable to the profiteers. And it ultimately results in the destabilization of the economy.

Socio-political Factors:

There are several other internal and external socio-political factors i.e. political certainty and stability, war, changes of governments, affecting the value of currency. These dilemmas are often attributed to third world countries and a country like Canada does not suffer from these predicaments. It has a stable political set-up and its foreign policy approach help it to remains away from world disputes. National disaster is another major reason that destroys the economy of a country but fortunately Canada has not suffered from any mass level catastrophe hitherto and has the ability and managed well minor natural disaster previously. So this factor is unable to affect the Canadian Dollar. But certain other external factors like international terrorism affects economy but on limited scale. In the events of post 9/11, Canada has managed to escape from terrorism and proved itself as safe haven for investors. These are reason that Canadian Dollar remains on constant appreciation as compared with American Dollar that suffered a major blow in the wake of Euro.

Investor’s Perception:

The above-mentioned factors contribute as whole to create a new factor i.e. investors confidence. The perception of the investors plays an important in the economic strength of a country in particular and its currency in general. The monetary view of the investors compels them to invest in Canada and/or save their reserve assets in the Canadian currency. In addition to above-mentioned factors, this factor is reinforced by official trade and taxation policies of the governments toward the investors and trading community.

Conclusion:

In additions to stated long term factors, current upraise in the value of Canadian Dollar is due some American economic phenomenon. Due to potential terrorist attacks, crashes in the stock markets and low interest rates in addition to the investors’ perception of future economic and terrorists threats has diverted the investors to Canada and has forced the local investors to keep their assets in the Canadian currency. Canadian economy has achieved a fiscal equilibrium and its higher interests rates and commodity based economy contribute toward the present appreciation of Canadian Dollar.

References

Katz, Samuel I. (1953). The Candia Dollar: A Fluctuating Currency. The review of Economics and Statistics. 35. 3. 236-243.

Murray, Norden and Vigfusson. (1996).  Excess Volatility and Speculative Bubbles in The Canadian Dollar: Real or Imagined. Ottawa. Bank of Canada.

[1] Samuel A. Katz as early as 1953 labeled Canadian Dollar as a fluctuating currency.
[2] The raw materials of these products are readily available within the country of its production.
[3] However Bank intervened in the late 1990s and raised the interest to impinge on sharp decline of Canadian Dollar that helped to improve the rapid devaluation.

 

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