In a speech on Tuesday the governor of the Bank of Canada denied rumours that the bank was trying to depreciate the dollar.
He said Canada does better with a floating exchange rate. Controlling the exchange rate would lead to greater fluctuations in output, inflation and unemployment.
Why? If the exchange rate is controlled and, for example, demand changes, then output and employment need to adjust. If the exchange rate is floating, it does some of the adjustment.
So the Bank of Canada targets inflation and the exchange rate is set by the market.
As we will discuss in chapter 4, the central bank cannot control the inflation rate and the exchange rate at the same time. It must choose one and let the other be determined by market forces.
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