Monetary policy was also more accommodative than it should have been through this period, as the Bank of Canada sought to moderate the upw...
Monetary policy was also more accommodative than it should have been through this period, as the Bank of Canada sought to moderate the upward pressure on the currency and to support aggregate demand as the global economy slowed because of the oil-price shock. In hindsight, the Bank failed to “recognize the extent to which the economy in general and the labour market in particular were coming under strain” (Bank of Canada Annual Report 1980, 17). In other words, the Canadian economy was operating closer to its capacity limits than was earlier believed. Fiscal policy was also very expansionary through this period. While the 1974–75 slowdown in Canada was relatively shallow compared with that in the United States, where policy was less accommodative, inflationary pressures intensified. To address these inflationary pressures, an anti-inflation program, including wage and price controls, was introduced by the government in late 1975,
and the Bank of Canada adopted a target for the narrow monetary aggregate, M1, with the objective of gradually reducing the pace of money growth and thus inflation. After weakening temporarily in 1975 and falling below parity with the U.S. dollar, the Canadian dollar recovered in 1976. Wide interest rate differentials with the United States provided considerable support for the currency, with provinces, municipalities, and Canadian corporations borrowing extensively in foreign capital markets. Foreign appetite for Canadian issues was enhanced by the removal in 1975 of the 15 per cent federal non-resident withholding tax on corporate bonds of five years and over.
Foreign borrowing helped to mask the effects of deteriorating Canadian economic fundamentals on the Canadian dollar. The currency moved up to the US$1.03 level during the summer of 1976 in volatile trading, but the election of a Parti Québécois government in Quebec on 15 November 1976 prompted markets to make a major reassessment of the Canadian dollar’s prospects. Political uncertainty, combined with softening prices for non-energy commodities, concerns about Canada’s external competitiveness related to rising cost and wage pressures, and a substantial current account deficit, sparked a protracted sell-off of the dollar. A History of the Canadian Dollar 75 Canada, $1, Trudeau just-a-buck, 1972 This example of “political currency” satirizes former Prime Minister Pierre Trudeau and was circulated during the campaign of 1972 prior to his second term in office. 76 A History of the Canadian Dollar Over the next two years, the Canadian dollar fell significantly, declining to under US$0.84 by the end of 1978. This occurred even though the U.S. dollar was itself depreciating against other major overseas currencies and despite considerable exchange market intervention by the Bank of Canada on behalf of the federal government to support the Canadian dollar. To help replenish its international reserves, the federal government established a US$1.5 billion stand-by line of credit with Canadian banks in October 1977. This facility was increased to US$2.5 billion the following April. A similar US$3 billion facility was organized in June 1978 with a consortium of U.S. banks. The federal government also borrowed extensively in New York and in the German capital market to assist in financing the current account deficit and to support the currency.
The Bank of Canada tightened monetary policy through 1978, with the Bank Rate rising by 375 basis points to 11.25 per cent by the beginning of January 1979. Early in 1979, the federal government undertook additional foreign borrowings, this time in the Swiss and Japanese capital markets. Notwithstanding the tightening in monetary policy, inflation pressures did not abate, even though the rate of monetary expansion was kept in line with announced targets, and the Bank Rate touched 14 per cent by the end of 1979. Against this backdrop, however, the Canadian dollar steadied and ended the year close to US$0.86.
No comments