The Bank of Canada will have to adjust monetary policy in response to the new strength in the loonie, Governor David Dodge suggested today.

Speaking to the Consejo Coordinador Empresarial (Business Coordinating Council) in Mexico City, Dodge reiterated that the Bank of Canada’s overriding goal will be to maintain inflation near 2% by trying to keep the economy operating as close as possible to its full production capacity.

“In Canada, we know that, with a stronger currency, the economy will have to rely more on domestic demand and less on foreign demand for ongoing, solid growth. We will take this into account as we set monetary policy,” Dodge said.

He suggested that in response international forces, both Canada and Mexico will to need to increase productivity in the face of fierce competition from China and other lower-cost countries. The economy will also have to adjust to “significant imbalances in global current- and capital-account flows”, and competitive pressure from new players in Asia.

To face these challenges, Dodge said the economy will need more high-productivity activities. For significant gains in productivity to resume, governments must ensure their microeconomic policies encourage flexibility and do not hinder innovation in the public and private sectors.

He said that Canada must keep reducing its ratio of public debt to GDP. “That ratio will need to decline further to give Canada the flexibility to meet the demands of our aging population.”

It will also need the appropriate microeconomic policies with regard to labour markets, intellectual property law, environment, and foreign investment. Social policies must, “strike a balance between facilitating the adjustments that need to be made and supporting those members of our society who are displaced by structural adjustment,” the governor said.

Dodge also reiterated the importance of free trade, via NAFTA and other multi-lateral negotiations. “For many firms and many employees, we know that adjustment can be painful and difficult. But in today’s world, not adjusting is not an option. Fortunately, in both our countries, we are making these adjustments under relatively favourable conditions.

“Global demand is strengthening, and credit conditions are good. We have a better knowledge of what we need to do. And we have made important progress in strengthening our macroeconomic frameworks. The challenges that we will face make it even more important that we continue to strengthen our policy frameworks in order to adjust to changing circumstances and to take advantage of potential gains. The faster we are able to adjust, the greater the wealth we can create for our citizens.”