The main objective of this paper is to analyze the impact of U.S. short- and long-term monetary policy under both flexible and managed floating systems, using the new CANDIDE Model 2.0. We have also examined the role of domestic monetary policy in the Canadian economy under both fixed and flexible exchange rate systems.
The following are some of the important findings of our study:
| 1. |
Our results support the traditional view that under the fixed exchange rate regime, monetary authorities cannot successfully pursue an independent monetary policy from its trading partners — an effort to increase money supply will be almost offset by increases in the balance of payments deficit.
In contrast, in the flexible exchange rate regime, monetary policy is more effective in producing an increased growth in output and employment. However the increased output growth comes at the cost of higher prices induced by increased wages and a depreciation of the Canadian dollar. |
| 2. |
Our results suggest that the impact of U.S. interest rates on investment, GNE, employment, productivity, and government debt is less severe in a pure floating exchange rate regime, compared to the managed floating system. However, the impact of U.S. interest rate policy on the Canadian inflation rate is worse in the case of flexible exchange rate regime. Even though real income and inflation are less favourable in both cases, our results indicate a trade-off between output growth and inflation.
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| 3. |
Our results imply that under a pure floating monetary authorities can determine the long-run rate of inflation in Canada independent of others. However, the United States and Canadian economies are interrelated during the adjustment process, even under the flexible exchange rates, through the terms of trade and the wage-price spiral channels.
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We are indebted to Dr. R.S. Preston, Director, CANDIDE Project, for his guidance and encouragement with this project. We are grateful to Dr. Levésque, Director, Economic Council of Canada, for patiently reading the first draft of this paper and offering several useful comments. We are also grateful to the staff of the Research Department, Bank of Canada for their co-operation in developing the financial sector of the CANDIDE Model 2.0. We are thankful to H. Saiyed for helping us with the simulation and to M. Willis for preparing the various tables and graphs. Finally, we are extremely grateful to D. Desaulniers for her expert typing.