total supply and demand in balance. similarly, when there is falling global demand for canadian - produced goods and services, the floating exchange rate will encourage demand for these goods and services, again helping to keep total supply and demand in balance. exchange rate movements and monetary policy this brings me to my next subject, which is how we at the bank of canada view movements in the exchange rate. as i said earlier, we do not have a target or a preferred level for the canadian dollar. but this does not mean that the value of the currency is unimportant, far from it. the exchange rate is something that we at the bank are always watching closely ; looking for the valuable information that helps us to better interpret and predict the strength of total demand for canadian goods and services. the way that we take the exchange rate into account as we conduct monetary policy is complicated. this is because the exchange rate can move for different reasons. sometimes, movements in the exchange rate reflect changes in the demand for a country's goods and services. but sometimes, they do not. this distinction is important, because the two types of movements have different implications for demand in the economy and, hence, for monetary policy. indeed, the reason behind a movement in the canadian dollar can be just as important for monetary policy as the movement itself. let me take a couple of minutes to explain. first, consider the type of currency movement that reflects changes in foreign demand. in 2003 and much of 2004, we saw a strong increase in the value of the canadian dollar. this reflected, at least in part, the strong demand for canadian exports, and a sharp rise in the global prices of many of these exports, particularly commodities. the stronger canadian dollar, in turn, encouraged imports and discouraged exports. this is an example of how the appreciation of the canadian dollar can work to dampen an initial increase in aggregate demand. were this dampening effect on aggregate demand to exactly offset the initial, direct increase in demand, all other things being equal, there would be no need for a monetary policy response. now, consider the other type of exchange rate movement, which does not reflect changes in demand for a country's goods and services. instead, it can reflect changes in foreign demand for that country's financial assets, or changes in domestic demand for foreign financial assets. for example, during the past two years, investors have become more concerned about the large and growing u. s. current account deficit which, according

. to be clear, inflation targeting is not an end in itself. rather, it is the best means of fulfilling our commitment to promote the economic and financial welfare of canadians. we pursue this objective by trying to keep the economy operating at full capacity ; that is, we aim for a balance between total demand and supply in the economy. when the demand for goods and services pushes the canadian economy against the limits of its capacity, and inflation is poised to rise above the target, the bank will raise interest rates to cool off the economy. and when the economy is operating below its production capacity, and inflation is poised to fall below the target, the bank will lower interest rates to stimulate growth. so by maintaining low and stable inflation, monetary policy promotes greater stability in economic output. a flexible exchange rate is an important part of our monetary policy framework. i hasten to add that we do not have a target or preferred level for the canadian dollar. i'll come back to the topic of the exchange rate in just a moment. but first, let me talk about how our monetary policy helps the economy to adjust to the powerful economic forces we see today. to begin with, low and stable inflation allows businesses and consumers to better read price signals in markets, which helps them to make better long - term decisions in the face of major economic developments. a second way that monetary policy helps with the adjustment process comes from our strategy of keeping total supply and demand in balance. in these circumstances, economic resources that are released by shrinking sectors where demand is weak can be absorbed by expanding sectors where demand is strong. of course, adjustment is never simple or without pain, especially at the personal level. but from a macroeconomic point of view, adjustment can take place with less social and economic cost when inflation expectations are well anchored and the economy is operating close to its potential. having a floating exchange rate is a third way in which our monetary policy framework helps with the adjustment process. let me explain how. changes in global demand for a country's goods and services tend to bring about movements in that country's currency. the resulting exchange rate movements help to keep balance in the economy by offsetting the impact of the change in demand. for example, rising global demand for canadian goods and services tends to lead to a stronger canadian dollar. the stronger currency, in turn, tends to restrain exports and to encourage imports. by restraining the demand for canadian - produced goods and services, the floating exchange rate helps to keep