Saint Valentine’s Day Economics

Saint Valentine’s Day is a moment of the year we revive friendship and love. Friendship and love are feelings but Economist would rather define them as strategic interactions between two or more players who are getting together to maximize their wellbeing. 

To celebrate (Saint) Valentine’s Day, some friends and lovers seeking to please each other exchange gifts. Some of these gifts are bought online. Here in Canada, sometimes, we find it economical to shop online from the United States (US), our southern neighbor. Some Canadian businesses also get their supplies of Valentine’s Day products from the US. An increase in households’ online shopping and in businesses’ supplies from the US induces an increase in the demand of the US dollar to pay for the transactions. Could this cause the US dollar to appreciate, viz. to rise, versus the Canadian dollar around Valentine’s Day? 

Note sure because, on the other hand, many American couples cross the US border around Valentine’s Day to spend time and money in Canada. Quebec Winter Carnival held in the beginning of February is one of the many attractions of our country. So, given the interaction between the two economies, out of curiosity, I am wondering how trade and tourism around Valentine’s Day affect our currencies.

To attempt answering for this question, I have observed the behavior of the Canada-US exchange rate on Valentine’s Day and the ten business days before that moment from 2005 to now. By Canada-US exchange rate I mean how much US dollar you get in exchange for one Canadian dollar. 
I have reported in the table below the exchange rate and its actual rate of appreciation on Valentine’s Days and its average value and average rate of appreciation ten business days before.

Over the sample, I have observed that:

• The Canadian dollar gains value or remains stable on Saint Valentine's Day,
• Ten business days before Valentine’s Day, the Canadian dollar lost value on average versus the US dollar only on three occasions: in 2006 and during the financial crisis in 2008, and 2009 when many US citizens lost their jobs and homes.

Obviously the most attractive one on the occasion is the Canadian dollar J.

Happy Valentine's Day to all!

The Canada-US Exchange Rate and Central Banks' Key Interest Rates

The Canadian dollar lost 2.8 % of its value relative to the US dollar between January 3 and10. This phenomenon is called depreciation. While the Canadian dollar was depreciating, I have noticed that the overnight rate, which is the key interest rate of our central bank, the Bank of Canada, was also falling. Over the following week, one can still observe that the overnight rate was leading the Canada-US exchange rate, viz. changes in this latter variable were preceded by changes in the former variable. I will give two examples, to illustrate my observations. First, the Canada-US exchange rate, i.e., the value of one Canadian dollar in terms of the US dollar, rose from .916 to .92 on January 13. On January 10, the previous business day, the overnight rate rose from 1.0001 % to 1.0003 %. Second, on January 17, the Canada-US exchange rate fell from .9152 to .9123 after the rise the previous day of the overnight rate from 1 % to 1.0001 %. All this time, the US central bank, the Federal Reserve Bank, maintained its key interest rate, the federal funds rate, at the level of .07 %. As a matter of fact, a higher short-term interest rate in Canada induces an increase in the foreign demand of Canadian assets (bonds and treasury bills), which raises the value of the Loonie (Loonie or Buck, that is how our Canadian dollar is nicknamed).

I now show how the actual rate of change in the Canadian-US exchange rate relates to the past, current, and future values of the key interest rate in both countries.  To do that, I have used daily series on exchange rate and key interest rates over a very short period of time ranging from January 2, 2012 to January 16, 2014. My sample has 503 observations. Only business days that are common to both countries are considered in the sample. For instance, July 1^st, Canada Day is a holiday for Canadians but not for our southern neighbors and on July 4, US citizens celebrate their independence whereas Canadians go about their businesses. Besides, I have retrieved data only over a short period of time to avoid what is called in the jargon structural breaks, which are shifts that can arise in the data due to the fact that central banks adjust over time the target for their key interest rates. In Canada, over the sample period the target for the overnight rate is 1 %, this means to keep inflation at the target of 2 % per annum, the Bank of Canada has to maintain the overnight rate around 1 %. The Federal Reserve Bank’s target range for the federal funds rate over the sample period is between zero and .25 %.    
 

 

The above table displays the correlation coefficients between the actual rate of change in the Canadian-US dollar and the past, current, and future key interest rates.  I have computed the contemporaneous correlation coefficients as the correlation between the exchange rate and the key interest rates of the previous day because the information available when the exchange rate is determined is the key interest rates of the previous day.

The data show a positive contemporaneous correlation between the Canada-US exchange rate and the key interest rates. The intensity of the relationship between the exchange rate and the future values of the key interest rates turns out to be stronger in absolute value in most of the cases compared to the intensity of the relationship between the exchange rate and the lag of the key interest rates.  

Bibliography
Wickens, Michael (2008) Macroeconomic Theory, A Dynamic General Equilibrium Approach, Princeton University Press, pp 280-93.

The Canadian Dollar over the First Half of January 2014

The Canada-US exchange rate, i.e., the value of one Canadian dollar in terms of the US dollar, has risen today after losing 2.8 % of its value last week. One Canadian dollar, today at noon, was worth .92 US$. 

On  January 6, 2014, the Canada-US exchange rate  moved from .9422 to .9382. Four days later, one Canadian dollar was traded against .916 US dollar. This latter level of the Canada-US exchange rate has not been observed since September 25, 2009.  See below the graph daily Canada-US exchange rate over the past seven years.

Canada-US Daily Noon Exchange Rate, January 2, 2008-January 13, 2014, Data Source: Bank of Canada

Over the sample period, the lowest value of the exchange rate, which is .9063, was observed on September 3, 2009 and its highest value, 1.0583, occurred on July 26, 2011. Its average value is .963.

When the Canadian dollar was falling last week, the overnight money market rate continuously fell from its level of 1.0016 % on January 3 to settle at 1.0001 % on January 9. The overnight money market rate, which is the Bank of Canada’s policy rate, is the interest rate applied to interbank day to day lending. A fall in this policy rate also occasions a fall in other short term commercial rates including the bond and Treasury bill yields. This renders investing in Canadian assets less and less attractive for foreign investors, reduces the demand for the Canadian dollar, and lowers its exchange rate.  

Also note that the Federal Reserve Bank’s key policy rate, the federal funds rate also fell from .08 to .07 on January 7.