dollar to devalue. but the true reasons for its demise were more deep - seated. this system, which had been viable, although prone to periodic crises, throughout the 1950s and 1960s, was clearly unable to cope in a world of liberalized trade and international capital mobility. the bretton woods system, while laudable in concept, proved to be flawed in practice. the main problem was that the imbalances that the system was supposed to address, through discrete changes in the parity value of the affected currencies vis - a - vis the u. s. dollar and gold, proved to be much larger and more intractable than the architects of the system had ever envisaged. moreover, countries were reluctant to adjust their currencies, even when the problems were shown to be fundamental. thus, authorities would often subvert domestic economic objectives, such as price stability, economic growth and full employment, in order to protect outdated parities. as a result, the system was in disequilibrium more often than not. and its adjustable nature did not prove flexible enough to help countries deal with the shocks that regularly hit the international financial system. while the adoption of floating exchange rates may have been more a matter of necessity than choice, floating rates did promise greater independence in the conduct of monetary policy and better insulation from external shocks. advocates of a floating regime, partly influenced by canada ’ s favourable experience with such a system in the 1950s, suggested that exchange rates would automatically adjust to correct external imbalances in an orderly and continuous manner. and this would give domestic policymakers greater freedom than under the pegged rate system as well as obviate the need for official intervention and large international reserves. experience with the floating rate system needless to say, experience under the floating rate system has not been problem - free. events did not unfold quite as its proponents had suggested, and the past 25 years have been characterized by volatile short - term movements and sizable long - term swings in most of the major currencies. the magnitude of these currency movements and our evident inability to explain them in a comprehensive, precise manner, led many observers to presume that such movements were driven by market speculation and that they were largely disconnected from economic fundamentals. there is no simple way to resolve this issue. nonetheless, it is possible to identify some of the forces that have influenced exchange rates through this period, either by shaping their broad movements or, at times, by contributing to

and 1994. fiscal policy concerns, at times coupled with political uncertainty, proved to be a volatile mix and led to serious financial market turbulence and speculative pressures, complicating the task of monetary policy. fortunately, the situation has recently improved considerably. inflation in canada is stable, at its lowest level in decades. and it has been somewhat below that in the united states since 1992. this implies a potential appreciation of the canadian dollar vis - a - vis the u. s. dollar over time, if the inflation differential persists. but other factors also tend to favour a stronger canadian dollar. first, deficit reduction by canadian governments has eased the uncertainty that had pervaded financial markets, thereby shrinking risk premiums in interest rates and reversing the currency weakness caused earlier by these premiums. second, canadian industries are in a stronger competitive position than they have been for years, and this has contributed to a sharp reduction of the persistent deficit in the current account of our international balance of payments. third, primary commodity prices are firm and likely to move higher with the pickup in global economic activity. in light of all this, it is not surprising that several analysts, as well as the bank of canada, expect a stronger canadian dollar in the future and think that the currency is currently undervalued relative to its longer - term fundamentals. why, then, has the canadian dollar not been stronger? the explanation lies mainly in the different cyclical positions of the canadian and u. s. economies. the more accommodative monetary conditions pursued in canada during the past two years have been consistent with the needs of an economy characterized by considerable excess capacity and an inflation rate that has tended to be in the lower half of the current 1 to 3 per cent target range. thus, lower interest rates and a relatively low canadian dollar have been temporarily appropriate for economic reasons. while no central bank ever wishes to have a weak currency, since late 1995, the bank of canada has encouraged easier monetary conditions - - conditions that, at times, have taken the form of lower interest rates and a somewhat softer dollar. put another way, the bank did not purposely push the dollar lower, but simply aimed for the path of monetary conditions that seemed appropriate given sluggish domestic economic conditions. the particular mix of interest rate and exchange rate adjustments necessary to achieve the desired path of monetary conditions is not under the direct control of the bank of canada. it is essentially determined by the markets. however, the canadian