could be purchased for 85 cents Canadian and by the end of 2000 the price had dropped to 65 cents. This decline however, has not been constant. Between 1990 and the end of 1991, before the recession, the dollar actually appreciated to three cents. The end of ninety-one marked the beginning of a steep depreciation of the dollar. In fact notwithstanding a few blips, the price of a dollar only leveled out in 1995 but not before sinking to 71 cents. This equilibrium did not last very long; by the beginning 1997, the dollar was sliding again only to stop two years later at around 65 cents. This all-time low was most likely considered unsustainable and the price slowly crept its way back towards the 70-cent level throughout 1999 only to drop back down to 65 cents by the end of 2000. That Canadian dollar over the 1990's has steadily declined 25%, cannot be simply what is known as a market error. The invisible hand of Adam Smith has not been waving around the foreign exchange and accidentally knocking down the Canadian dollar. A steady long term trend downward.The question of what economic fundamentals have forced the depreciation of the Canadian dollar is indeed a sordid one. Over the years economists have developed several theories regarding the determinants of exchange rates. However because the downfall of the Canadian dollar seems to be a long-term trend I will disregard the short-term determinant known as the interest rate parity. The interest rate parity hypothesis claims that because most foreign exchange transactions involve financial asset, which have no sunk costs and are readily convertible. Therefore in the short term arbitrage accounts for most of the fluctuations in the exchange rate. This implies that the forward exchange rate should be an unbiased estimate of the future spot rate. Unfortunately this is generally not the case in a simple model (see appendix) but still economist believe it to be true (Isard p 89). A...
