December 15, 1998
Bank of Canada Review Article
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December 14, 1998
Downward wage rigidity
There has recently been considerable discussion about the ability of inflation to facilitate the adjustment of prices and wages and thus enhance economic performance. The discussion centres on whether wages are downwardly rigid. Wages are said to be downwardly rigid if it is difficult for the wages of some workers to fall despite underlying supply and demand pressures for decreases. Some authors have suggested that if downward nominal wage rigidity is prevalent it would be desirable to select a positive rate of inflation as the target for monetary policy. In this article, the authors evaluate the wage-rigidity hypothesis. They first examine the empirical evidence to assess whether the degree of downward rigidity is significant in Canada. They then analyze some key assumptions of the wage-rigidity hypothesis and its implications for employment. They also look at the empirical evidence on whether the combination of downward wage rigidity and low inflation has reduced employment. -
December 13, 1998
Survey of the Canadian foreign exchange and derivatives markets
In April 1998, the Bank of Canada conducted its triennial survey of activity in the Canadian foreign exchange and derivatives markets. This was part of a coordinated international effort in which 43 countries carried out similar surveys. The foreign exchange market in Canada is the 11th largest in the world, and the Canadian dollar is the 7th most-traded currency globally. The average daily turnover of traditional foreign exchange transactions has grown by 23 per cent (to US$37 billion) since the last survey in 1995. Although this growth was substantial, the rate of increase has declined steadily since the survey began in 1983. The average daily turnover for single-currency interest rate derivatives during April 1998 was US$6.4 billion, an increase of 48 per cent over the previous survey. -
December 12, 1998
Conference summary: Information in financial asset prices
This article summarizes the proceedings of a conference hosted by the Bank of Canada in May 1998. This was the second Bank conference to focus directly on issues concerning financial markets. The topic for 1998—the extraction of information from the prices of financial assets—has been an area of extensive research by central banks worldwide because of its connection to monetary policy. The Bank wanted to encourage such work by Canadian researchers as well as solicit feedback on work conducted internally. It also wanted to broaden the understanding of the interplay in the markets between central banks and other participants. It therefore assembled a wide mix of researchers, central bankers, and market participants. The summary briefly outlines the papers presented as well as the wrap-up discussion. -
November 14, 1998
Lower inflation: Benefits and costs
The federal government and the Bank of Canada have been committed for some time to achieving and maintaining price stability as a way to foster a rising standard of living for all Canadians. To support this objective, the inflation-control target range of 1 to 3 per cent was recently extended through to the end of 2001. By then, the government and the Bank plan to announce a long-run target for monetary policy. In this article, the authors provide an overview of the most recent empirical evidence on the benefits of lower inflation. They draw on an extensive earlier survey and on work presented at two recent conferences on price stability hosted by the Bank of Canada. They find that, when inflation and tax interactions are taken into account, there are large benefits to lowering inflation. When these benefits are compared with the transitional costs associated with lowering inflation, significant positive benefits remain. However, the authors note that the extension of the inflation-control targets to the end of 2001 allows further research to ensure an operational definition of price stability that will help Canadians achieve a high standard of living. -
November 13, 1998
Currency crises and fixed exchange rates in the 1990s: A review
Currency crises in the 1990s, especially those in emerging markets, have sharply disrupted economic activity, affecting not only the country experiencing the crisis, but also those with trade, investment, and geographic links. The authors review the theoretical literature and empirical evidence regarding these crises. They conclude that their primary cause is a fixed nominal exchange rate combined with macroeconomic imbalances, such as current account or fiscal deficits, that the market perceives as unsustainable at the prevailing real exchange rate. They also conclude that currency crises can be prevented through the adoption of sound monetary and fiscal policies, effective regulation and supervision of the financial sector, and a more flexible nominal exchange rate. -
November 12, 1998
The LVTS—Canada's Large-Value Transfer System
The LVTS is an electronic network for sending and receiving large-value payments. It is expected to become operational in the first half of 1999. Major chartered banks and other large deposit-taking institutions will provide access to the system for their clients in the financial, corporate and government sectors. Canada’s LVTS exceeds world standards for risk control in large-value systems. The author explains how this is achieved through the netting, bilateral and multilateral credit limits, collateral, and loss-sharing procedures used in the event of a default, and, as a last resort, a guarantee by the Bank of Canada. The LVTS gives participating institutions certainty of settlement for their LVTS positions every day, even if one or more participants default. This greatly reduces systemic risk in the financial system. Moreover, the LVTS supports finality of payment; that is, it makes funds unconditionally and irrevocably available to the receiver. Finality is highly desirable when the amount of the payment is substantial, or when exact timing is critical. Since the LVTS will carry the great majority of the value of all payments in Canada, it should be considered the core of the national payments system. -
November 11, 1998
A primer on the implementation of monetary policy in the LVTS environment
The author summarizes the objectives and key elements of the framework that the Bank will use to implement monetary policy under the new payments system. The article includes a comparison of the key features of the pre-LVTS framework with that to be used in the LVTS environment. It also features a glossary of terms with respect to the Bank's monetary policy operations. -
August 14, 1998
Recent economic and financial developments (with update on 12 August)
This commentary, which was completed at the end of June, provides an account of economic and financial developments in Canada since the publication of the last Monetary Policy Report in mid-May 1998. International developments since May have increased the degree of uncertainty surrounding the outlook for the Canadian economy. While most indicators of domestic demand as well as the growth of the monetary and credit aggregates suggest continued relative buoyancy in the domestic economy, the foreign trade data bear clear evidence of the drag arising from the situation in Southeast Asia and Japan. However, with the various risks to the outlook appearing to be greater than previously thought, the Bank will continue to monitor developments carefully and constantly reassess its judgment of Canada's economic and financial situation. The core rate of inflation is expected to remain in the lower half of the 1 to 3 per cent inflation-control target range for the remainder of the year. Update 12 August 1998: The degree of uncertainty surrounding the international situation and its implications for the Canadian economy remains high. In Southeast Asia, economic activity continues to decline and financial markets remain nervous. In Japan, the latest economic data point to further weakness. In sharp contrast, the U.S. economy continues to outperform expectations, with domestic demand showing robust growth according to the latest information. As well, recent developments in Europe point to moderate economic expansion. Here in Canada, allowing for the effects of temporary factors such as layoffs associated with the strike at General Motors, the underlying momentum in the economy continues to be positive. The many cross-currents affecting the Canadian economy are evident in the data released since the commentary on recent developments was completed. In the resource sector, production and exports have been weak because of reduced demand from Asia. However, exports of other goods, particularly non-automotive manufacturing goods, have been buoyant, reflecting strong demand from the United States. In Canada, retail sales continue to rise and sales of existing homes are also growing, consistent with the pickup in the growth of household credit. At the same time, new home construction has weakened, in part because of strikes in the Greater Metropolitan Toronto area. Business investment and the growth of total business credit have also remained relatively strong. Recent information on overall investment intentions for 1998 show marked growth, consistent with the latest monthly indicators on investment in machinery and structures, but the resource and non-resource sectors are showing divergent near-term trends. The latest labour force data also point to sustained underlying growth in employment and incomes. On the whole, recent data suggest that real GDP increased by about 2 1/2 per cent (annual rate) in the second quarter, somewhat less than anticipated at the time the commentary was completed. Our current estimate is that the various strikes and other production disruptions (the largest being the spillover effects from the GM strike in the United States) lowered second-quarter real GDP growth by about 1/2 of a percentage point. Thus, in the absence of these disruptions, growth would have been closer to 3 per cent. Economic activity in Canada will continue to be affected by the GM strike and associated layoffs into the third quarter, complicating interpretation of the economic data for this period. This and the uncertainties on the external front underscore the need for continued close monitoring of economic developments. On balance, the positive elements of ongoing strength in consumer and investment spending in Canada, together with the high level of U.S. demand for our products, continue to support economic expansion at rates that will reduce unused capacity. On the inflation front, the latest information points to core inflation remaining in the lower half of the 1 to 3 per cent inflation-control target range. While the effects on the price level from exchange rate depreciation will be working to raise inflation, offsetting factors, such as excess supply in the economy and price competition from Asian producers, will keep overall inflation pressures subdued. Since completion of the commentary, monetary conditions have eased further as a result of the depreciation of the Canadian dollar. As noted in the commentary, the extent of the current international uncertainty is causing volatility in financial markets and fluctuations in monetary conditions over a wide range. -
August 13, 1998
Labour force participation in Canada: Trends and shifts
A key determinant of the potential growth of an economy is the rate at which the labour force increases, which depends both on population growth and on changes in the participation rate. Cyclical factors related to the economic environment can play a significant role in affecting the participation rate, as can structural factors and demographic trends. From the mid-1970s to the end of the 1980s, the participation rate rose almost without interruption to a record high of 67.5 per cent. In contrast, between 1990 and 1995, it declined sharply and has been relatively steady at around 65 per cent since 1995. In this article, the author analyzes the participation rate of age and gender groupings in order to better understand the factors leading to these developments and their implications for future movements in the aggregate rate. While cyclical factors contributed to the decline in the participation rate in the 1990s, structural factors (such as an increase in school attendance rates and the increasing use of computer technology) and demographic trends (the aging of the population) have had a substantial impact. The conclusion reached is that, while some recovery is to be expected, the aggregate participation rate is unlikely to return to its 1989 peak over the next decade or so.