john murray : price puzzles and the exchange rate remarks by mr john murray, deputy governor of the bank of canada, at mount allison university, sackville, new brunswick, 19 november 2013. * * * accompanying charts can be found at the end of the speech. thank you for having me here today. i expect that in new brunswick you are well aware that there are large and persistent gaps between the prices charged in the united states and in canada for similar goods. many canadians feel the same way. we can ’ t blame canadian consumers for being both puzzled and annoyed. isn ’ t free trade supposed to close this price gap? shouldn ’ t competitive market forces cause domestic and foreign prices to converge? and if prices can ’ t move, shouldn ’ t our flexible exchange rate adjust to offset any differences? and, finally, if neither prices nor the exchange rate are moving to close these gaps, is something wrong with the system? these are good questions, and they deserve good answers. in my speech today, i ’ ll try to provide them. but i face two challenges. first, there is a great deal that remains to be learned, so i won ’ t be able to provide complete and conclusive answers. second, i don ’ t have enough time to adequately review everything that has been learned, so i ’ ll have to hit the highlights. let ’ s first get a sense of what we ’ re dealing with. how egregiously is the law of one price being violated? let ’ s start with what things would look like in a perfect world. in a fully competitive world, free of impediments to trade, one would expect to see what we economists call the law of one price ( lop ) enforced. cross - border arbitrage would ensure that the prices of identical goods sold at home and abroad, and expressed in a common currency, were the same. to what extent has this “ law ” been observed? chart 1 shows two different measures of the price gaps between canada and the united states. the first compares the cost of living in the two countries over the past 30 years. this is a less - stringent condition than the lop, since it doesn ’ t test whether the same price is observed in canada and the united states on each and every good, but rather whether the general level of prices in the two countries is the same. to do this, it compares the cost of a similar basket of consumer goods and services north and south

lack of demand for building work. the household sector experienced some financial strain as job losses constrained disposable income. although most indicators show that the decline in the real economy had bottomed out in the first half of 2009, consumers were, until the third quarter of 2009, still somewhat pessimistic about the prospects for future performance of the economy and its impact on their finances. the elevated rate of unemployment continued tight lending conditions and a need to address weaker household balance sheets are expected to continue to impact consumption expenditure negatively. also, on average, the credit standing of consumers has continued to deteriorate. i have briefly highlighted the key issues raised in the financial stability review. more detailed analyses are available in the publication itself, and will be highlighted by the authors ’ presentations. i trust that you will find these interesting, stimulating and relevant to the current environment and invite you to provide comment as part of the important process of ongoing debate on financial stability. thank you.