Bank of Canada says Canada-U.S. price gap adjusts with currency rates, but slowly

OTTAWA – The Bank of Canada is weighing in on the problem of the Canada-U.S. retail price gap, suggesting the vexing phenomenon may not be as persistent, inevitable or irrational as it may seem.

In a speech to Mount Allison University in New Brunswick, the bank’s deputy governor, John Murray, acknowledges that the gap appears to defy exchange rate movements that have of late brought the loonie to near parity with the U.S. dollar.

But Murray says that is not evidence of a market failure _ although it is not perfect _ nor does it say that given enough time the price gap does not close as currencies gravitate toward parity. It just takes time for the adjustment to become apparent.

“Despite the large and persistent price gaps that are frequently observed between Canadian and foreign prices at the aggregate level, more detailed work suggests that deviations from the law of one price and purchasing power parity are not as large or as persistent as many believe,” he said.

“While significant price discrepancies exist, the reasons for them can largely be explained and are not evidence of serious market failure. Market forces are at work and are generally pushing prices and the exchange rate in the right direction.”

The finding is unlikely to provide comfort to the Harper government, which signalled in the throne speech last month that it was preparing new measures to combat the price gap. And it will likely be cold comfort to Canadian shoppers, whose frustration with price differences was noted by a Senate committee report on the issue.

The bank’s own data, obtained from posted prices on the Internet of about 150 different goods, suggest the gap has closed significantly from the about 20 per cent level when the Canadian dollar achieved parity in 2007, to as low as nine per cent in the last survey conducted in October.

A separate survey by the Bank of Montreal, also conducted in June, appeared to agree with the central bank’s findings.

In the March budget, federal Finance Minister Jim Flaherty removed tariffs on some sports equipment and baby clothes to see if it would influence prices, and last month’s throne speech announced the government would “take further action to end geographic price discrimination against Canadians.”

It did not say how it would do this, but additional measures may be forthcoming in next spring’s budget.

The Bank of Canada appears less concerned than the government on the issue, however, although it cites tariffs as one cause.

Murray notes that although Canadians now complain about paying more locally for the same item as they would across the border, that only started happening in the last eight years or so as the loonie began a steady climb toward parity.

For most of the past 30 years, he notes, prices in Canada have actually been significantly lower when the exchange rate difference is reflected.

As well, the deputy governor said there are other factors going into the retail price of goods in any market _ for instance tariffs, quotas, levels of competition and cost differences, such as for transportation.

But Murray adds that the bank’s own internal research suggests there is evidence that exchange rate changes are passed through to prices, although it takes time and there is not always an exact value correlation. And, he says, the research shows that persistent price gaps impact exchange rate fluctuations over time.

“The bottom line,” he said, “is that although the estimated macroeconomic effects might not appear to be very large, exchange rate pass-through does exist and is operating in a predictable, helpful, way.”

Murray adds it would be fruitless for the Bank of Canada to try and intervene by using monetary policy _ manipulating interest rates _ because the price differences are mostly driven by forces of supply and demand and can’t be suppressed forever.

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