3. Real Exchange Rate Indexes for the Canadian Dollar

Principles of Macroeconomics (with Xtra!)

Info icon This preview shows pages 1–3. Sign up to view the full content.

19 B ANK OF C ANADA R EVIEW A UTUMN 1999 Real Exchange Rate Indexes for the Canadian Dollar Robert Lafrance and Pierre St-Amant, International Department Real exchange rate (RER) indexes for Canada measure the movement of Canadian prices against foreign prices, expressed in a common currency. Two key elements in calculating an RER index are the weights employed and the price or cost indicators selected. In principle, the best weighting systems are those that take account both of bilateral trade between countries and of the competition that their businesses give each other in third markets. Because one partner—the United States—weighs so heavily in Canada’s trade, the weighting system generally makes little difference in calculating Canadian RER indexes. When exchange rates for some of our other trading partners are fluctuating sharply, however, it is useful to keep an eye on indexes that cover several countries. In practice, the most important choice to make is the price or cost indicator on which to build the RER index. Theory and empirical evidence alike favour RER indexes calculated on the basis of unit labour costs (ULC). Yet ULC data are published infrequently and late, and they typically cover only the manufacturing sector. Economic policy-makers should, therefore, consider RER indexes constructed with other indicators as well. ith the Canadian economy becoming increasingly open to foreign markets, interest has been growing, for some years, in the competitiveness of Cana- dian businesses. Because competitiveness cannot be measured directly, it has been necessary to find ways to monitor its performance indirectly. A favourite method used by researchers and by various national and international agencies has been to devise real exchange rate (RER) indexes. This article offers both a theoretical and a practical analysis of the merits and shortcomings of the different weighting systems and price indicators used in preparing RER indexes and compares various RER indexes that have been calcu- lated for the Canadian economy. 1 Definition and Meaning RER indexes are measures of how domestic prices (costs) move against foreign prices (costs), when they are expressed in a common currency. They can be written in the following manner: where represents an index of domestic prices (costs) in Canadian dollars; , represent price (cost) indicators for countries whose businesses compete with Canadian firms; , represent bilateral exchange rates of the Canadian dollar against the cur- rencies of those countries; and , are the relative 1. Some of the ideas expressed in this article can be found in Lafrance et al. (1998). Lafrance (1988) also deals with this subject. W RER P / P 1 E 1 ( 29 w 1 P 2 E 2 ( 29 w 2 P n E n ( 29 w n ( 29 = P P 1 P n E 1 E n w 1 w n
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

20 B ANK OF C ANADA R EVIEW A UTUMN 1999 weights of those countries in the index.
Image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern