Exchange rates and the floating dollar

Fix the direction before you divide

An exchange rate is a price, and every price needs a unit. 1.36 CAD/USD means 1.36 Canadian dollars buy one US dollar — CAD per USD. The reciprocal, $1/1.36=0.7353$ USD/CAD, is the same rate quoted the other way. Every conversion is a unit cancellation: to turn CAD into USD, divide by CAD per USD; to turn USD into CAD, multiply.

Worked example — Prairie Grid's purchasing

Prairie Grid Energy has C$5,000 to spend on US parts at 1.36 CAD/USD: $5{,}000 / 1.36 = \mathbf{US\$3{,}676.47}$ — =B2/B3. A US$1,200 laptop costs $1{,}200 \times 1.36 = \mathbf{C\$1{,}632.00}$ — =B4*B3.

A cross rate links two currencies through a third. With 0.92 EUR/USD (euros per US dollar), euros per Canadian dollar is

$$\frac{\text{EUR}}{\text{CAD}}=\frac{\text{USD}}{\text{CAD}}\times \frac{\text{EUR}}{\text{USD}}=\frac{1}{1.36}\times 0.92=0.6765$$

=(1/B3)*B5. The USD cancels top and bottom; if it does not, the fraction is upside down.

Appreciation, and who wins

If CAD/USD moves from 1.40 to 1.36, fewer Canadian dollars buy a US dollar — the Canadian dollar has appreciated (the US dollar's CAD value fell $1.36/1.40-1=-2.86\%$, =1.36/1.40-1). The number went down and the dollar went up: that is the trap, and the callout below is the rule.

A stronger dollar helps importers, Canadian travellers abroad and anyone buying foreign goods; it hurts exporters and the tourism trade. A weaker dollar reverses every line — good for exporters and for visitors to Canada. Canada is a resource exporter, and the floating rate is a shock absorber: when commodity prices fall the dollar drifts down, which makes other Canadian exports cheaper abroad and cushions the blow.

What moves it

The rate is set by supply and demand for Canadian dollars in the foreign-exchange market. The determinants: relative interest rates (higher here → capital inflows → CAD demand), relative inflation (higher here → CAD buys less → depreciation), commodity prices (Canada sells them), and demand for Canadian assets — stocks, bonds, businesses.

Why the Bank leaves it alone

The Bank of Canada does not target the exchange rate. Letting the dollar float is what lets it target inflation instead: a country can fix its currency or run its own monetary policy, not both. Under an agreement with the federal government the Bank would intervene only in exceptional circumstances — an imminent market breakdown, or extreme moves threatening long-run growth — using the Exchange Fund Account, and the last time it did so was September 1998.

The channel, end to end

A Bank of Canada hike → Canadian rates above foreign rates → capital flows in → demand for CAD rises → CAD appreciates → imports cheaper, exports dearer → demand cools and import prices fall → inflation lower. Run it backwards for a cut. This is the second-fastest of Lesson 8.5's four channels and the one the paper asks about most.

More conversions

C$2,500\to ‘=2500/1.36‘=US$1,838.24. US$850\to ‘=850\ast 1.36‘=C$1,156.00. €300 → =300*1.36/0.92 = C$443.48. A move from 1.36 back to 1.40: =1.40/1.36-1 = +2.94 % for the USD — the CAD depreciated.