Do We Need a Lower Canadian Dollar to Be Competitive in the World Market - Essay Example

Do we need a lower Canadian dollar to be competitive in the world market? Do we need a lower Canadian dollar to be competitive in theworld market? Introduction The exchange rate is a key economic variable that dictates world economies. Real exchange rate is defined as the rate at which the goods and services of one country are traded for the goods and services of another country (Mankiw, 2014). This means that if a Canadian citizen buys a laptop manufactured in China, s/he will be paying in Canadian dollars while the Chinese manufacturing company will be receiving the money in their own currency, Yuan. Here the exchange rate acts as a medium to settle the transaction occurring between the two countries in two different currencies, Canadian Dollars and Yuan. While strong global economies like the United Kingdom, USA, and the like, have a high exchange rate, others such as Japan have deliberately kept their currency quite low. In economically terms, lower Canadian Dollars mean that the exchange rate is depreciated (Pettinger, 2008). Same is the case with Japan which has devalued the fixed exchange rate of Yen yet its economy is plunging new heights (Obel, 2013). So, a higher exchange rate does not imply greater value nor does it determine the wellness of the state of any economy as is evident in the case of Japan. Factors Affecting Exchange Rate Government policies are important factors that shape the macroeconomic landscape through their power to introduce variances in the various variables. That said, the global landscape also determines various aspects of exchange rates such as oil prices, interest rates, and so on (Oyejide, 1986). These factors in turn affect the competitiveness of a particular currency in the world market. Sanchez (2005) has explained the relationship between the interest rate and the exchange rate. Lower interest rates imply cheaper prices for borrowing or taking an interest, which reduces the incentive to save. As a result, people do not prefer saving which is why the demand for a currency reduces. Inevitably, with lower demand comes a devaluation of the currency. In our case, lowering the interest rate will reduce the exchange rate of the Canadian Dollar thereby depreciating the currency. A drop in the exchange rate therefore makes importing a costly endeavor reducing the incentive to import and making the exports more competitive in the global market. Therefore, this can be beneficial for the Canadian economy as increased exports will provide the funds to finance construction of firms and hence, greater employment. The exchange rate, apart from being influenced by a plethora of other factors, is also subject to governmental policies regarding trade. The monetary policies designed by policy makers drive the exchange rate and determine how international trade occurs (Frieden, 2013). Because trade with different countries involves transactions in various different currencies, therefore, the exchange rate becomes a vital and unavoidable tool during international trade. In the age of globalization, international trade has become commonplace and exchange rate takes a more important position in the global arena. Impact of Low Exchange Rate Yes, I believe that lowering the Canadian dollar will help it to be more competitive in the Global Market. When a Canada’s currency falls in worth against the currency of other countries, it is known as depreciation. The depreciation of a country’s currency means that the imports coming into that country and all the products or raw materials being bought into the country will be more costly to buy than before while the products or commodities being exported by the country will be cheaper than before the depreciation. In the case of depreciation, when Canada’s currency gets devalued by the government, it makes the exports from Canada more affordable for other importing countries and hence, more competitive for other exporting countries. When Canada faces currency depreciation then the quantity and proportion of exports of Canada will increase and rise. On the other hand, the amount and number of imports into Canada will decrease and fall. This happens because the value of the currency in the international market falls and the amount of goods that the currency could buy also falls causing the imports to be decreased as now they would be more expensive. The exports increase due to the fact that now as the Canada’s currency has fallen according to exchange rate than the other countries can buy more of that country’s products causing the exports to increase. As the exports of Canada increases, the domestic and native industries and businesses benefit and enjoy from the growing and increasing sales. As the exports increase so does the work of the industries and factories which export these products, merchandise and commodities also increases. As the work load increases on these factories and industries they employ more workers, laborers, employees and machines to coupe up with the increased demand causing the unemployment in the country to decrease. When the net export increases that is the export of the country even after subtracting the imports of the country are higher means that it will help increase the aggregate demand of the country’s products and will eventually lead Canada to achieve higher and greater economic growth. As Canada will face economic growth than the local people will have more money to enjoy more facilities and services inside the country. With higher economic growth the incomes of the local people will increase which will eventually increase the tax revenue for the government. This tax revenue can then be utilized to make schools, colleges, hospitals, roads and various other services for the benefit of the local people (Moynihan and Titley, 2007). As the depreciation of the currency grows, the costs and prices of imports also increase causing the inflation in the country to increase. This type of inflation is called Imported Inflation. This will cause the costs of the products which are imported into the country to increase hence creating problem for those people who consume those imported goods. The United States of America and China can be seen as great examples. We have seen that how the China has depreciated its currency causing its exports to increase massively. The uplift in the export of China has proved to be very beneficial and favorable for them as now we can see that almost all of the products we buy are now made in China. This has increased the amount of foreign currency flowing into their country. And imports are not even that expensive for them as the foreign money flowing is than reutilized for buying the imports being consumed in their industries and factories. The depreciation of the Canadian dollar will also help Canada to achieve and enhance the balance of payments of Canada. The balance of payment is the difference between the exports and imports of a country. As the exports increase the foreign currencies start flowing in and can be used to pay for the costs of the imported items. Most countries want a Balance of Payment surplus that is the amount of exports from their country should be more than the import into the country. Depreciation helps in achieving higher balance of payments as it helps in increasing the exports of the country. This will help Canada to be more competitive as the other countries would find the Canadian made products to be cheaper and would tend to buy these products from Canada helping the exports to increase. Therefore, the most immediate effect of the exchange rate is on the next exports as it affects both the exports and the imports. And since the net export equates the difference between exports and imports, exchange rate impacts a country’s balance of payments. A lower exchange rate increases exports and decreases imports and therefore has a positive effect on the economy by making exports more competitive. Canadian policy makers in the government can exploit economic theory of aggregate demand to influence the exchange rates. Because they affect net exports, the exchange rates also affect aggregate demand. But while lower exchange rates may reduce imports, demand for some imports may not drop as effectively for example if it’s a raw material that is currently not being manufactured locally which has to be imported. Therefore, while imports may drop overall, some products may not represent a reduction in demand considering their nature or necessity. The result is a theoretical concept known as the J curve which occurs in the graphical representation forming a curve similar to the alphabet in its curvature. Conclusion Therefore, lowering the Canadian Dollar will make the global market more competitive for it as exports will become more desirable as imports become more and more expensive. A negative incentive will be provided for importing as import prices shoot up. However, despite this fact, some imports may not stop immediately in the short run. Overall, though the effect is largely beneficial for the Canadian economy as the exchange rate depreciates. Thus, a devaluation of currency will make the Canadian Dollar more competitive in the external environment by making exports cheaper and imports more expensive. References Frieden, J. (2013). Globalization and exchange rate policy (1st ed., pp. 344-357). Retrieved from http://scholar.harvard.edu/files/jfrieden/files/globalization_and_exchange_rate_policy.pdf Mankiw, N. (2014). Principles of macroeconomics (1st ed.). Stamford, CT: Cengage Learning. Moynihan, D., & Titley, B. (2007). Economics (1st ed.). Oxford: Oxford University Press. Obel, M. (2013). Why Japans Yen Is Sinking And Its Stock Market Is Soaring, So Far Its Not A Currency War. International Business Times. Retrieved 23 July 2014, from http://www.ibtimes.com/why-japans-yen-sinking-its-stock-market-soaring-so-far-its-not-currency-war-1091316 Oyejide, T. (1986). The Effects of Trade and Exchange Rate Policies on Agriculture in Nigeria (1st ed.). International Food Policy Research Institute. Pettinger, T. (2008). The Impact of falling exchange rate. Economics Help. Retrieved 23 July 2014, from http://www.economicshelp.org/blog/437/trade/effects-of-falling-exchange-rates/ Sanchez, M. (2005). The Link Between Interest Rates And Exchange Rates. European Central Bank Working Paper Series, (548). Retrieved from https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp548.pdf Read More