Vertical Trade, Asymmetric Exchange Rate Pass-Through, and Canada’s Exchange Rate Regime
نویسندگان
چکیده
The recent sharp appreciation of the Canadian dollar vs. the US dollar poses difficulties for the Canadian economy and reignites the debate as to whether Canada should fix the Canadian dollar to the US dollar by implementing a unilateral peg or forming a monetary union. We compare the welfare of different combinations of monetary and currency policies in an open-economy macroeconomic model that incorporates two unique features of the Canadian economy: the high level of vertical trade with the US and the prevalent use of the US dollar as the invoicing currency for both imports and exports. This comparison generates two insights about the exchange rate regime of Canada. First, the vertical trade makes it more difficult for a flexible exchange rate to balance the Canadian economy by adjusting relative prices. The higher degree of economic integration resulting from the vertical production and trade favors a fixed exchange rate regime or a single currency. Second, because Canadian firms often use the US dollar as the invoicing currency for both imports and exports, they undertake most of the currency risk. Relative to other countries with a flexible exchange rate regime, in particular the US, Canada is more exposed to currency fluctuations, which leads to a higher cost of a flexible exchange rate regime in Canada. JEL classification: F3, F4
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