interest rates in canada to be below those in the united states, there has been - - rightly - - a strong market perception that the relative weakness of the canadian dollar is temporary and that a future appreciation will compensate investors for the lower yields on canadian dollar assets. but experience has taught us that this process of exchange rate / interest rate interaction works well only if there are no concerns in the markets about canadian economic policies. as we found out in 1994 - 95, when there were concerns about fiscal policy, a decline in the value of the canadian dollar can generate a loss of confidence and expectations of further depreciation of the currency, not of subsequent appreciation. the upshot of all this is that, with a floating currency, market participants need a consistent and credible policy framework to help anchor their expectations about future movements in the exchange rate. such a framework rests, above all, on a firm undertaking by the authorities to preserve the domestic purchasing value of the currency. i believe that our inflation - control targets, by giving a clear, precise view of this commitment, provide a strong underpinning for the external value of the canadian dollar. what is my main message to you today? canada is in better shape now than it has been for many years to face the economic challenges of the future and to reap the benefits of changing technology and an increasingly integrated world economy. but, for this scenario to unfold, there will have to be continued commitment by the authorities to prudent, credible economic policies. as far as monetary policy goes, this means a pledge to maintain canada ’ s good inflation performance. that is a pledge i can give without reservation.

accepted that the central bank will keep inflation under control, will businesses and individuals not respond immediately to signs of strong demand pressures by seeking to raise prices and wages. the recent u. s. experience attests to this. indeed, strong credibility has been a key factor that has enabled the fed to take account of the possible changes in economic structure that i mentioned earlier and to steer the u. s. economy successfully towards levels of aggregate demand and employment that in the past would have been thought incompatible with maintaining low inflation. it is by conducting monetary policy prudently during the economic upswing that we at the bank of canada will have the credibility needed when our economy begins to operate at levels that test its potential to produce. the role of the exchange rate i would now like to take a moment to underscore the important role that the exchange rate plays in the conduct of canadian monetary policy and to explain what i meant earlier when i used the term “ monetary conditions ”. in a medium - sized, open economy, like canada ’ s, a good deal of the impact of monetary policy actions is channelled through the exchange rate. but because financial markets do not always respond to events in completely predictable ways, we do not know exactly how interest rates and the exchange rate will move and interact. that is why we at the bank have found it useful to construct an index of monetary conditions to help us keep track of the combined effect of these two variables on aggregate demand in canada. to understand how we use monetary conditions in practice, let us look at the recent situation where cyclical differences have meant that the canadian economy has been weaker than the u. s. economy. in these circumstances, the need for accommodative monetary conditions in canada required the bank of canada to take action to lower interest rates. but the magnitude and timing of those interest rate reductions depended, to an important degree, on the exchange rate response. with the canadian dollar roughly stable between late 1995 and late 1996, the easing in monetary conditions could take place through measured declines in interest rates. the strengthening canadian dollar through the latter part of 1996 accelerated the decline in interest rates, as the bank of canada sought to maintain the degree of monetary ease achieved in the autumn of 1996. with the economy gathering momentum since then, persistent weakness in the canadian dollar through june 1997 prompted a small increase in interest rates in order to offset an undesired further easing in monetary conditions. i might add that, since cyclical differences have required