Suppose Canadian real GDP is currently equal to potential GDP.Then,because of events elsewhere in the world,European investors decide to hold fewer Canadian financial assets,which leads to a sustained depreciation of the Canadian dollar.If the Bank of Canada is committed to its inflation target then it should

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A depreciation of the Canadian dollar would make Canadian goods cheaper to foreigners, likely increasing exports and potentially leading to higher demand and inflation in Canada. To combat this inflation and stick to its inflation target, the Bank of Canada would likely implement a contractionary monetary policy, which involves increasing its target for the overnight interest rate to cool down the economy.

Suppose Canadian Real GDP Is Currently Equal to Potential GDP