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short essays and reports on the economic issues of the day
2007 ■ Number 26

One Dollar = One Loonie
Christopher J. Neely
n September 21, 2007, the Canadian dollar—nicknamed
since 1996 the Canadian budget has usually been in surplus and
the “loonie,” after the water fowl depicted on its reverse—
never in a substantial deficit. As a result, the net Canadian governreached parity with the U.S. dollar for the first time since
ment debt fell from about 70 percent of GDP in 1995 to only
1976 (see chart). That is, one loonie could purchase one U.S.
about 25 percent of GDP in 2007. These policies have successfully
dollar. The Canadian financial press celebrated this milestone.
reduced Canadian inflation. As a result, since 1996, Canadian
That the Canadian dollar equaled the value of one U.S. dollar
long-term interest rates have almost always been lower than their
is not intrinsically important; there is nothing special about a
U.S. counterparts. Prior to 1996, U.S. long-term rates were almost
price (an exchange rate) equal to one. Nevertheless, the recent
always lower. These measures have enabled the loonie to be viewed
decline in the Canadian/U.S. dollar exchange rate will affect ecoas a stable store of value.
nomic decisions. For example, consumers in both Canada and
Finally, global growth and fears about the international secuthe United States now find U.S. goods to be relatively cheaper
rity situation have driven the recent rise in prices of Canadian
than Canadian goods. This benefits Canadian consumers but
export commodities such as oil and gold. Researchers at the Bank
will make it more difficult for Canadian producers to compete
of Canada have noted that such strengthening in commodity
with their American counterparts.
demand has historically buoyed the price of the loonie.1
Before considering why the loonie has appreciated against
While U.S., Canadian, and global factors have all contributed
the U.S. dollar, one should know that exchange rates appear to
to the rise in the loonie’s value, the case highlights the benefits of
be only weakly connected to macroeconomic variables such as
improved Canadian economic policies and the potential dangers
output, prices, and interest rates. Specifically, macro models have
of the low U.S. saving rate. ■
not had much success in predicting exchange rates. But we can
1Amano, R. and van Norden, S. “Terms of Trade and Real Exchange Rates: The
reasonably identify some important qualitative factors, at least
Evidence.” Journal of International Money and Finance, 1995, 14(1),
in hindsight.
pp. 83-104.
Many analysts have ascribed the recent rise in the loonie mainly
to U.S. economic problems. Very low domestic savings, for
example, contributes to an enormous U.S. current account
deficit, equal to almost 6 percent of gross domestic product
CAD/USD Exchange Rate
(GDP). Some argue that a reduction in this deficit requires
a fall in the dollar’s value. Perhaps as a result of concern
Nominal Exchange Rate
about this scenario, China has allegedly reduced its demand
Real Exchange Rate
for the U.S. dollar as a reserve asset. More recently, problems
with subprime mortgages and the subsequent reduction in
the federal funds target have reduced international demand
for U.S. assets. All of these factors have probably contributed
to recent weakness in the U.S. dollar. Indeed, the U.S. dollar
has declined by about 30 percent against a basket of major
currencies since early 2002.
A less-discussed factor in the appreciation of the loonie
against the dollar, however, is the substantial improvement
in Canadian economic policy that began about 16 years ago.
In 1991 the Bank of Canada began “inflation targeting,”
making a numerical range for inflation the primary or sole
NOTE: Monthly averages of the Canadian/U.S. dollar (CAD/USD) nominal and real (inflationadjusted) exchange rates from January 1973 to October 2007.
objective of monetary policy. The early 1990s also saw a
turnaround in chronically large Canadian budget deficits;


Views expressed do not necessarily reflect official positions of the Federal Reserve System.