Fundamentals of the Canadian Dollar and the Prevalence of the Dutch Disease

Abstract

The purpose of the paper is to discuss the factors affecting the Canadian dollar and determine whether it is a commodity driven currency. It further assesses whether the Dutch disease is prevalent in Canada. While much research has been done to explain exchange rate movements, it remains one of the more complicated areas of economics. However, there is some common ground among the various models, and several basic determinants of the exchange rate may be identified. Modification to these models may be applied for specific situations as in the case of Canada, where commodities are found to be one of the important components of exchange rate models. In Canada’s specific case, commodities form an esstial part of the overall economic output. Therefore their inclusion in such models is necessary. With a large commodity trade portfolio, the country is susceptible to the Dutch disease in cases of a commodity boom. However, research shows that in the case of Canada, it is not a problem of currency appreciation but external factors leading to depreciation of the currency of their largest trading partner, the US. Therefore, the Dutch disease may not be prevalent, but the lack of diversification in the trade portfolio may be leading to negative effects ON the manufacturing sector. A similar effect is reflected by the empirical findings where commodity driven currency appreciation is negatively related to manufacturing output. However, given the multiple economic interactions, these results should be treated with caution.