The Importance of Sound Monetary Policy: Some Lessons for Today

Abstract: In this paper we revisit the Canadian experience with floating exchange rates since1950. Canada was a pioneer in successfully adopting a floating exchange rate during the Bretton Woods pegged exchange rate regime. Since then, most advanced countries have followed the Canadian example. A key finding of our paper based on historical narrative and econometric analysis is that economic performance under floating depended on its monetary policy performance as Milton Friedman originally argued in his seminal 1953 article. Canadian monetary policy performed best once it adopted inflation targeting as a nominal anchor. Also, as Friedman argued, Canada’s floating exchange rate provided it with a modicum of insulation from external shocks, especially commodity price shocks that influenced both the level and volatility of the real exchange rate over the past three decades. The Canadian experience with floating (along with that of other small pen economies such as Australia, New Zealand and Sweden) and inflation targeting became a model for the conduct of monetary policy in emerging countries.

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