of canada has to be forward - looking, taking actions based on projections of future pressures on inflation. monetary policy aims to keep inflation low and stable by keeping overall demand in line with supply. when demand is projected to rise beyond the economy's ability to meet that demand, threatening to push inflation above target, the bank will act to dampen some of that demand by raising interest rates. conversely, when demand is weak, threatening to take inflation below target, the bank will lower interest rates to stimulate demand. this symmetric, forward - looking approach to monetary policy has a stabilizing influence on the economy, thus helping to prevent costly boom - and - bust cycles. if we waited for inflation to increase or decrease before tightening or loosening monetary policy, we would be too late, and there would be a risk that the economy would be less stable. settlement balances are the deposits that financial institutions hold at the central bank to settle their net positions with one another. the role of the exchange rate except for a brief period from 1962 to 1970, when the exchange rate was fixed, canada has had a floating exchange rate since 1950. 2 today, the canadian dollar is worth about 86 u. s. cents. four years ago, it was worth 63 u. s. cents. our flexible exchange rate regime is an essential ingredient of our inflation - targeting system. it allows us to follow an independent monetary policy, suited to our own economic circumstances, which would not be possible if we had to set monetary policy with the objective of maintaining a fixed exchange rate for the canadian dollar. at the same time, inflation targeting means that our floating exchange rate acts as a " shock absorber, " helping our economy adjust to changes with less pain and less disruption than if the exchange rate was fixed. so, we do not have a target for the external value of the canadian dollar. with only one instrument — the target for the overnight rate — to carry out monetary policy, we couldn't hit two targets, one for inflation and one for the exchange rate. but saying that we do not have a target for the exchange rate doesn't mean that we ignore it. on the contrary, we monitor the exchange rate closely to assess the effects of currency movements on aggregate demand for canadian goods and services, and the consequences for future inflation. the fact is that the exchange rate is an important price in the canadian economy. it directly affects the canadian dollar price of everything we import and export, thus sending strong price

commodities produced by canada fell, and our terms of trade weakened. reflecting the downturn in world commodity prices, the canadian dollar depreciated against the u. s. dollar. the depreciation helped to mitigate the negative shock for commodity producers. and, more importantly, it encouraged the manufacturing sector to expand and absorb the resources — labour and for further information, see james powell, a history of the canadian dollar, http : / / www. bankofcanada. ca / en / dollar _ book / index. html ; also available from publications distribution, bank of canada, ottawa, ontario, k1a 0g9. capital — that were released from the commodity - producing sector. thus, the depreciation of our currency helped to offset the negative effects of the asian crisis on aggregate demand for canadian goods and services and thus pre - empted downward pressures on prices and wages. in this way, the flexible exchange rate acted as a shock absorber to mitigate the effects of the weakening terms of trade on the overall level of economic activity, while encouraging economic adjustment. let me now turn to the second episode. in the past three to four years, canada's terms of trade have improved sharply. the basic story has been one of strong global economic growth, leading to a surge in world demand and prices for oil and gas, lumber, metals, and other primary commodities. the resulting rise in canadian incomes has also boosted demand by canadian households and businesses. over this period, the canadian dollar has appreciated by more than 30 per cent against the u. s. greenback, and indeed significantly against many other currencies. this stronger canadian dollar has dampened the positive shock for commodity producers and made manufacturing less competitive. as a result, resources have been reallocated from the manufacturing sector to the commodity and services sectors. this adjustment has helped keep overall supply and demand in balance and inflation pressures in check. in this sense, the past four years have been the reverse of the situation in 199798. once again, the flexible exchange rate has helped to stabilize the economy and to encourage adjustment — this time in the context of strengthening terms of trade. it's useful to compare these two recent terms - of - trade shocks — which occurred when monetary policy was anchored by an inflation target — with an earlier shock when monetary policy was not conducted with an explicit target. during 1997 - 98, when our terms of trade were weakening, cpi inflation averaged 1.