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Short-term Capital Movements and the Flexible Canadian Exchange Rate, 1953–1961*

Published online by Cambridge University Press:  07 November 2014

T. L. Powrie
T. L. Powrie*
Affiliation:
University of Alberta
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Extract

The external value of the Canadian dollar was remarkably stable during most of the recently ended regime of the flexible exchange rate. Short-term capital movements which tended to offset net shortages or surpluses of foreign currency arising from other transactions made an important contribution to this stability. This paper is an investigation of the causes of those generally stabilizing short-term capital movements.

Each of seven categories of short-term capital movements is considered, some categories being components of others. The seven categories, taken from the international accounts published by the Dominion Bureau of Statistics, are as follows. An arbitrary short name for each is given in brackets.

  1. 1. (Total private). The sum of the three following items, consisting of capital movements of a short-term nature not carried out by the Canadian government or central bank.

  2. 2. (Bonds). Net trade between Canada and other countries in outstanding Canadian bonds and debentures.

  3. 3. (Canadian dollars). The change in foreigners' holdings of Canadian dollars.

  4. 4. (Other). Other capital movements, adjusted. This is the balancing item D17 in the official Canadian international accounts, adjusted to remove a variety of irrelevant transactions.

  5. 5. (US dollars). The change in Canadian holdings of bank balances and other short-term funds abroad, excluding the official reserves. It consists largely of US dollar assets. It is one component of “Other” above.

  6. 6. (Commercial credits). This is the remainder of “Other” above, and consists of all other non-government transactions including changes in loans and accounts receivable and payable.

  7. 7. (Official). The change in the official reserves of gold and foreign exchange.

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 30 , Issue 1 , February 1964 , pp. 76 - 94
Copyright
Copyright © Canadian Political Science Association 1956

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Footnotes

*

This paper is a revision of part of my D.Phil, thesis submitted to Oxford University in 1961. I am grateful to Sir Donald MacDougall for his helpfulness as my supervisor. Most of the present version was written while I was a member of the Institute for Economic Research, Queen's University.

References

1 In principle one might wish to allow those speculators to have based their forecasts on some weighted average of past prices other than simply the average for the previous quarter. However, high correlation among various possible choices of past prices inclines us to include only one in the regression analysis, and P n−1 seems as reasonable as any.

2 This is the type of speculative activity envisaged by Rhomberg, R. R., “Canada's Foreign Exchange Market: A Quarterly Model,” IMF Staff Papers, 04, 1960.Google Scholar

3 The argument that follows is much indebted to Eastman, H. C., “Aspects of Speculation in the Canadian Market for Foreign Exchange,” this Journal, 08 1958.Google Scholar

4 Harrod, R. F., International Economics (Cambridge, 4th ed., 1958), 86.Google Scholar

5 Eastman, H. C. and Stykolt, S., “Exchange Stabilization in Canada, 1950–54,” this Journal, 05, 1956, 221.Google Scholar

6 Wonnacott, Paul, in “Exchange Stabilization in Canada, 1950–4: A Comment” (this Journal, 05, 1958)Google Scholar, made the point that capital movements which merely resist any movements in the exchange rate can contribute to the rate's stability, and Eastman and Stykolt in an accompanying note put the point into a mathematical form much more sophisticated than the arithmetic example in the text above. Their discussion was about the effectiveness of the Canadian Exchange Stabilization Fund's apparent policy of resisting all movements in the free exchange rate; both sides in the discussion seem to have taken it for granted that private short-term capital movements were related to (Pn — Nn ), and it is of interest to point out briefly how their argument about the effect of the Fund's policy would have to be modified if private short-term capital movements were actually related to (Pn —P n−1).

In Figure 1, curve A is the path of the exchange rate in the absence of any stabilizing shortterm capital movements. Curve B is the path of the rate as stabilized by short-term capital movements which are related to (Pn − Nn ). Curve C is the path as further modified by Exchange Fund operations related to (Pn − P n−1 ). In Figure 2, A is the same as in Figure 1. Curve B′ is the path of the rate as modified by private short-term capital movements related to (P n − P n−1 ), and curve C′ is the path as further modified by Fund operations also related to (P n − P n−1 ). As Wonnacott, Eastman, and Stykolt discussed the effect of Exchange Fund operations in terms of the difference between curves B and C, they must have assumed implicity that private short-term capital movements were a function of (P n − N n ). However, if private short-term capital movements were actually a function of (P n − P n−1 ), then the difference between curves B′ and C′ is a better illustration of the effect of Exchange Fund intervention. In Figure 2, compared with Figure 1, the Fund has less effect on the timing of turning points, for curves B′ and C′ both have their turning points where they cross A, whereas curve C has its turning points where it crosses curve B. The Exchange Fund also seems to achieve a somewhat greater reduction in the range of fluctuation in Figure 2 than in Figure 1. The reason for this can be seen by inspection of peak turning points. In Figure 1, after B has reached its peak, C continues to rise until it crosses B. In Figure 2, after B′ has reached its peak, C′ continues to rise only until it crosses A. That is, the peak of C′ cannot be as high relative to the peak of B′ as the peak of C is relative to the peak of B. The size of these differences between the two figures would vary as the curve A assumed different shapes.