of income, these higher prices imply a decline in living standards for canadian consumers. retailers who feel unable to pass on these price increases to consumers will have to absorb them in lower profits which, in turn, will mean lower returns for their shareholders. the bottom line is that the decline in commodity prices has made us less well off than we were before. and we have to adjust to this reality. these effects are unavoidable, even if we were able to prevent the canadian dollar from falling. in fact, if the currency were not allowed to move at all, the adjustment would be slower and more costly, taking place through reductions in wages which usually involve sharper fluctuations in output and employment. under a floating exchange rate, the process is facilitated by some downward movement in the dollar which spreads the burden of adjustment. over the years, this has been an important justification for a flexible exchange rate in canada - - that adjusting through exchange rate movements to the shocks that periodically hit our economy makes for a generally smoother and fairer process than adjusting through reductions in output, employment, and wages. but i do not want to leave you with the impression that foreign exchange markets always know the appropriate value for a currency. they sometimes push too far once a trend is established in one direction or another. indeed, i believe that during this latest episode of global financial turbulence, markets exaggerated the commodity connection of the canadian dollar. for example, our exports of highly manufactured goods, apart from the important motor vehicle sector, have grown by nearly 20 per cent over the past 12 months, and now represent about 30 per cent of our merchandise trade. this development seems to have been largely overlooked. monetary policy response so, what can and should the bank of canada do about the exchange rate in times of international financial turbulence and major external shocks? first of all, let me remind you that the objective of canadian monetary policy is to hold the rate of inflation within a range of 1 to 3 per cent. this target, jointly agreed upon by the government and the bank of canada, reflects the conclusion that low inflation will contribute to a stronger, more stable economic performance over time. if we are to fulfill our commitment to keep inflation low and stable, monetary policy must remain focused on that objective. the exchange rate and interest rates are the channels through which monetary policy operates and they must be allowed to adjust to help achieve the inflation targets. but what if the momentum of currency movements pushes the canadian dollar beyond any level that is justified on

suffered substantial losses in certain markets, they sought to reduce their exposure to emerging markets more generally. but this rapid withdrawal of funds brought to the surface areas of weakness in some of these economies, making investors still more nervous. the recent events in russia are a prime example of this process. the apparently contagious nature of these developments has led to some pessimistic predictions of recession in the world economy. how concerned should we be about this? while the international environment has turned out to be more difficult than most people had thought earlier, let me reassure you that it is certainly not all negative. to be sure, the situation in japan is worrisome - not only because of that country ’ s economic importance but also because of its strong trade and financial links with other troubled asian economies. but, and this is an important but, japan has the capacity and the financial wherewithal to turn its situation around. with resolute action to speed up the implementation of measures to deal with its ailing banking sector and to kickstart its domestic economy, the present concerns would dissipate. more importantly, economic activity in the united states has been very robust and is expected to remain healthy. in canada, too, and in europe the situation is positive. this is certainly not insignificant, for north america and europe together account for more than half of world output. and recent declines in medium - and long - term interest rates to record low levels are helping to sustain domestic spending in all industrial countries. with this as background, i would now like to turn to the impact of these international developments, and of the associated uncertainties and pressures in financial markets, on canada. how is our economy faring? the international developments of the past year have affected our economy more than previously anticipated. and there is no doubt that those canadian industries and regions that depend on the production of primary commodities are facing considerable difficulties. to appreciate this particular link between recent international developments and the canadian economy, let me point out that asia, including japan, absorbs between 30 and 35 per cent of the world output of certain key primary materials. so it is not surprising that world commodity prices have been hit hard by the asian crisis. the recent events in russia, which is a major commodity producer, have added to the uncertainty about the outlook for the world supply and prices of primary commodities. because of all this, the us dollar prices of commodities that are important to canada have fallen by about 15 per cent over the past