Throughout the 1980s, the Canadian dollar traded in a wide range, weakening sharply during the first half of the decade, before staging a strong recovery during the second half. Early in the period, the Bank’s policy was to moderate the effects of large swings in U.S. interest rates on Canada, taking some of the impact on interest rates and some on the exchange rate (Bank of Canada Annual Report 1980). For the Bank to react in this way, it needed more flexibility, and in March 1980, the Bank Rate was linked to the rate for threemonth treasury bills, which was established at the weekly bill auction. Canadian short-term interest rates rose sharply through 1980 and into the summer of 1981, with the Bank Rate touching an all-time high of 21.24 per cent in early August 1981, before moderating through the remainder of the year. At the same time, the Canadian dollar came under significant downward pressure. Important factors behind its depreciation included political concerns in the lead up to the Quebec referendum in May 1980, weakening prices for non-energy commodities, and the introduction of the National Energy Program by the federal government in October 1980, which prompted a wave of takeovers of foreign-owned firms by Canadian-owned firms, particularly in the oil sector. By mid-1981, policy-makers became concerned that the exchange rate slide would begin to feed on itself. Consequently, the minister of finance asked the chartered banks to reduce their lending to finance corporate takeovers that would involve outflows of capital from Canada.
Nevertheless, confidence in the Canadian dollar continued to erode through 1982 on concerns about the commitment of Canadian authorities to an anti-inflationary policy stance, and the cancellation of a number of large energy projects. With the dollar falling below US$0.77, the Bank of Canada allowed short-term interest rates to rise to prevent the increasing weakness of the Canadian dollar "from turning into a speculative rout” (Bank of Canada Annual Report1982). The Bank also reluctantly announced in November 1982 that it would no longer target M1 in its fight against inflation. Among other things, financial innovation had undermined the link between money growth and inflation. Research also revealed that the small changes in interest rates needed to keep money growth on track were insufficient to really affect prices or output. In testimony before the House of Commons Finance Committee, Governor Bouey said "We did not abandon M1, M1 abandoned us” . In other words, narrow money growth had failed to provide a reliable monetary anchor.
While the currency recovered to about US$0.82 on the Bank of Canada’s actions and on positive market reaction to the introduction of a restrictive budget by the federal government, the respite proved to be short-lived. Although for the most part, the Canadian dollar held its own against its U.S. counterpart through 1983, it weakened sharply in 1984 and the first half of 1985, as did other major currencies, as funds were attracted to the United States by high interest rates and relatively favourable investment opportunities.
In September 1985, amid growing concerns about global external imbalances and speculative pressures in favour of the U.S. dollar, the G-5 major industrial countries agreed in the Plaza Accord to bring about an orderly depreciation of the U.S. dollar through a combination of more forceful concerted exchange rate intervention and domestic policy measures. Although the overseas currencies began to appreciate against the U.S. dollar, the Canadian dollar continued to depreciate against its U.S. counterpart on concerns about weakening economic and financial prospects in Canada and falling commodity prices. The failure of two small Canadian banks—the Canadian Commercial Bank and the Northland Bank—may have also temporarily weighed against the Canadian dollar.
The Plaza and Louvre Accords
Named after the Plaza Hotel in New York, the Plaza Accord was a 1985 agreement among France, West Germany, Japan, the United States, and the United Kingdom aimed at correcting large external imbalances among major industrial countries and resisting protectionism. In addition to encouraging an orderly depreciation of the U.S. dollar, each country agreed to specific policy measures that would boost domestic demand in countries with a surplus, notably Japan and West Germany, and increase savings in countries with deficits, especially the United States. Two years later in Paris, the G-5 countries, along with Canada, agreed to intensify their economic policy coordination in order to promote more balanced global growth and to reduce existing imbalances. It was also agreed that currencies were now broadly in line with economic fundamentals and that further exchange rate shifts would be resisted. The success of policy coordination among industrial countries remains a hotly debated issue. While global protectionist pressures were averted, overly expansionary policy in Japan contributed to a speculative bubble in asset prices that subsequently collapsed, causing considerable and lasting damage to the Japanese economy. The ability of concerted exchange rate intervention to influence the value of the U.S. dollar has also been the subject of considerable controversy.
After touching a then-record low of US$0.6913 on 4 February 1986, the dollar rebounded, following a concerted strategy of aggressive intervention in the foreign exchange market, sharply higher interest rates, and the announcement of large foreign borrowings by the federal government. Initially stabilizing at about US$0.72, the dollar began an upward trend against the U.S. dollar, which lasted through the remainder of the decade.
In February 1987, Canada joined other major industrial countries in the Louvre Accord aimed at intensifying policy coordination among the major industrial countries and stabilizing exchange rates. Pursuant to this Accord, Canada participated on several occasions in joint interventions to support the U.S. dollar against the German mark and the Japanese yen. Although the Canadian dollar dipped briefly following the stock market "crash” in October—the Toronto Stock Exchange (TSE) fell 17 per cent over a two-day period—it quickly recovered.
Through 1988 and 1989, the currency continued to strengthen owing to various factors, including a buoyant economy led by a rebound in commodity prices, expansionary fiscal policy at both the federal and provincial levels, and a significant tightening of monetary policy aimed at cooling an overheating economy and reducing inflationary pressures. Positive investor reaction to the signing of the Free Trade Agreement (FTA) with the United States in 1988 also supported the currency.92 The Canadian dollar closed the decade at US$0.8632.