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The Fear Up North Is That Their Economy Is Heading South
Subject Interest Rates
Topic Monetary Policy
Key Words Recession, Interest Rates, Gross Domestic Product, Merchandise Trade
News Story

The U.S. is Canada's most important trading partner. Exports to the U.S. account for 80 percent of Canadian merchandise trade. Fears that the U.S. economy is slowing naturally bring fears that Canada's economy will follow. These worries caused the Canadian central bank to reduce its short-term interest rates by one-half percent to try to stimulate domestic demand. The Bank of Canada reduced its benchmark bank rate to 5.25 percent from 5.75 percent. Canadian banks responded to the cut in the bank rate by lowering the prime rate to 6.75 percent. This will effectively lower other interest rates that are based upon a bank's prime rate.

Canada's gross domestic product grew by 2.6 percent in the fourth quarter of 2000, compared with a 4.5 percent increase in the third quarter. The 2.6 percent increase was less than the forecasted rate of growth of 3.0 percent. Manufacturing output fell by 0.7 percent and unemployment rose to 6.9 percent. More importantly, the number of new jobs created in the economy fell significantly.

Canada's monetary policy has generally followed that of the U.S. Up until last fall, Canada's central bank set its rates by matching the changes announced by the Federal Reserve Board. It now sets dates in advance, and makes announcements at that time on the direction of monetary policy. Canada also cut personal income taxes at the start of the year in an effort to stimulate consumer demand.

Both the announcement of the rate cut and the comments by central bank members indicate that many are worried that the U.S. slowdown could be more pronounced than anticipated, leading to increased concern about the health of Canada's economy.

(Updated April 1, 2001)

Questions
1. How would a recession in the U.S. impact the Canadian economy?
2. How do changes in U.S. interest rates affect Canadian gross domestic product?
3. How is the U.S. dollar - Canadian dollar exchange rate determined? What affect does a decrease in U.S. interest rates have on the exchange rate?
Source Timothy Pritchard, "New Worries of Slowdown Spur Canada to Cut Rates," The New York Times, March 7, 2001.

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