Canada’s Experience with a Flexible Exchange Rate in the 1950s: Valuable Lessons Learned

• Canada’s lengthy experience with a flexible exchange rate regime has had an important impact on the development of macroeconomic theory and policy in open economies. • This article focuses on the 1950–62 floating-rate period because the flexible exchange rate, combined with a high degree of capital mobility between Canada and the United States, provided an unprecedented experiment for macroeconomic policy. • The Canadian experience over this period highlighted the two key benefits of a floating rate: smoother and less costly adjustment to external shocks and the opportunity to operate an independent monetary policy to achieve low and stable inflation. • Canada’s experience also led to the development of the Mundell-Fleming model and a better understanding of the impact of monetary and fiscal policies in open economies. anada’s experience with a flexible exchange rate regime in the twentieth and twentyfirst centuries is remarkable not only for sheer length, but also for its impact on macroeconomic theory and policy in open economies.1 Although Canada had a flexible exchange rate regime over the periods 1933–39 and 1950–62, and has maintained one since 1970, this article focuses on the important lessons learned from the intermediate period in the 1950s because economic historians consider it the most influential.2 The purpose of the article is to examine the two most notable lessons from the Canadian experience. First, it highlighted the two key, and still important, benefits of a flexible exchange rate regime: namely, its ability to insulate the domestic economy from external shocks by facilitating a smoother and thus less costly macroeconomic adjustment, and the fact that it permits the operation of an independent national monetary policy.3 Second, Canada’s experience led to a better understanding of the impact of monetary and fiscal policies in an open economy with a high degree of capital mobility. Moreover, the Canadian experience demonstrated that because a flexible exchange rate is an endogenous market-determined variable, its effectiveness as a macroeconomic shock absorber depends on its being supported by a coherent monetary and fiscal policy framework