Revisiting the Case for Flexible Exchange Rates in North America

Abstract: This paper provides econometric and qualitative evidence that flexible exchange rate regimes have played important roles in stabilising the Canadian and Mexican economies in the face of asymmetric shocks, nominal rigidities, and limited international labour and capital mobility. Empirical evidence from Canada and from the more recent period in Mexico (1995-present) is organised around three propositions: one, the economies of Canada, Mexico, and the United States often experience large asymmetric shocks and the correlation between their business cycles is relatively low; two, exchange rates in Canada and Mexico are primarily driven by macroeconomic fundamentals and adjust appropriately to large asymmetric shocks, which are often caused by commodity price movements; and, three, flexible exchange rates facilitate adjustment to shocks in the underlying fundamentals.