International Investment and Interest Rate Linkages under Flexible Exchange Rates

  • Pentti J. K. Kouri


One of the main arguments against the Bretton Woods system of pegged exchange rates was that it seriously limited the freedom of Central Banks, with the exception of that of the United States, to use monetary policy for domestic stabilisation. With the growth of the Eurocurrency markets and other channels of international investment interest rates in different countries tended to be equalised by arbitrage, except at times of speculation when substantial margins developed in an anticipation of an exchange rate change. The other side of the same phenomena was the problem of ‘offsetting capital flows’. An independent tightening (or easing) of monetary policy in some country would induce an inflow (outflow) of capital that would offset, at least partially, the intended effect of the policy on the monetary base. The other two manifestations of this lack of monetary independence were the transmission of external business cycles and in particular the problem of imported inflation. In principle the first problem could have been taken care of by the assignment of fiscal policy to domestic stabilisation but in none of the major industrial countries could fiscal policy be flexibly used for this purpose. The result was the recurrence of situations of conflict between external and domestic objectives of monetary policy, bound to arise when one instrument is used to achieve two targets.


Exchange Rate Interest Rate Monetary Policy Real Interest Rate Real Return 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Aliber, Robert Z., ‘The Interest Parity Theorem: A Reinterpretation’,Journal of Political Economy 81, no. 8 (Nov/Dec 1973) 1451–9.CrossRefGoogle Scholar
  2. Aliber, Robert Z., ‘Attributes of National Monies and the Independence of National Monetary Policies’, in Aliber, Robert A. (ed.) National Monetary Policies and the International Financial System Chicago: University of Chicago Press, 1974 (a).Google Scholar
  3. Balassa, B., ‘The Purchasing Power Parity Doctrine: A Reappraisal’, Journal of Political Economy, 72, no. 6 (Dec 1964) 584–96.CrossRefGoogle Scholar
  4. Black, F., ‘Capital Market Equilibrium with Restricted Borrowing’, Journal of Business, 45 (July 1972) 444–55.CrossRefGoogle Scholar
  5. Black, F., International Capital Market Equilibrium with Investment Barriers’, unpublished manuscript (Sep 1974).Google Scholar
  6. Branson, William H., ‘The Minimum Covered Interest Differential Needed for International Arbitrage Activity’, Journal of Political Economy 77, no. 6 (Nov/Dec 1969) 1028–35.CrossRefGoogle Scholar
  7. Dixit, A. K. and S. M. Goldman, ‘Uncertainty and the Demand for Liquid Assets’, Journal of Economic Theory, 2, no. 4 (Dec 1970) 368–82.CrossRefGoogle Scholar
  8. Fischer,S., ‘The Demand for Index Bonds’, working paper no. 132, M.I.T. (May 1974).Google Scholar
  9. Fisher, Irving, The Theory of Interest, New York: Macmillan Co., 1930.Google Scholar
  10. Foley, D. and M. Sidrauski, Monetary and Fiscal Policy in a Growing Economy, New York: Macmillan Co., 1971.Google Scholar
  11. Frenkel, Jacob A., ‘Elasticities and the Interest Parity Theory’, Journal of Political Economy 81, no. 3 (May/June 1973): 741–7.Google Scholar
  12. Frenkel, Jacob A. and Levich, Richard M., ‘Covered Interest Arbitrage: Unexploited Profits?’, unpublished manuscript, 1974.Google Scholar
  13. Gailliot, H. J., ‘Purchasing Power Parity as an Explanation of Long Term Changes in Exchange Rates’, Journal of Money, Credit and Banking, H, no. 3, (Aug 1970) 348–57.CrossRefGoogle Scholar
  14. Grassman, S., ‘A Fundamental Symmetry in International Payments Patterns’, Journal of International Economics, 3 (1973) 105–16.CrossRefGoogle Scholar
  15. Hodgson, J. S., ‘An Analysis of Floating Exchange Rates: The Dollar-Sterling Rate, 1919–25’, Southern Economic Journal, xxxix, no. 2 (Oct 1972) 249–57.CrossRefGoogle Scholar
  16. Holmes, J. M., ‘The Purchasing Power Parity Theory: In Defense of Gustav Canel as a Modern Theorist’, Journal of Political Economy, 75, no. 5 (Oct 1967) 686–95.CrossRefGoogle Scholar
  17. Jensen, M. C., ‘Capital Markets: Theory and Evidence’, Bell Journal of Economics and Management Science, 3 (Autumn 1972 ) 357–98.Google Scholar
  18. Johnson, Harry G., ‘The Case for Flexible Exchange Rates, 1969’, Federal Reserve Bank of St Louis Review (June 1970) 12–24.Google Scholar
  19. Kindleberger, C. P., ‘The Benefits of International Money’, Journal of International Economics, 2 (1972) 425–42.CrossRefGoogle Scholar
  20. Kindleberger, C. P., International Economics, 5th edition, Homewood, Illinois: Richard D. Irwin Inc., 1973.Google Scholar
  21. McKinnon, Ronald I., ‘Monetary Theory and Controlled Flexibility in the Foreign Exchanges’, Princeton Essays in International Finance, no. 84, International Finance Section, Princeton University, June 1969.Google Scholar
  22. Makin, J. S., ‘Equilibrium Interest Rate or Special Drawing Rights’, Southern Economic Journal, 41, no. 2 (Oct 1974) 171–81.CrossRefGoogle Scholar
  23. Mayers, D., ‘Nonmarketable Assets and Capital Market Equilibrium under Uncertainty’, in M. C. Jensen (ed.) Studies in the Theory of Capital Markets, New York: Praeger Publishers, 1972, 223–48.Google Scholar
  24. Merton, Robert C., ‘Lifetime Portfolio Selection under Uncertainty: The Continuous Time Case’, Review of Economics and Statistics (Aug 1969) 247–57.Google Scholar
  25. Merton, Robert C., ‘Optimum Consumption and Portfolio Rules in a Continuous-Time Model’, Journal of Economic Theory, 3 (Dec 1971) 373–413.CrossRefGoogle Scholar
  26. Merton, Robert, C., ‘An Analytic Derivation of the Efficient Portfolio Frontier’, Journal of Financial and Quantitative Analysis, VII, no. 4 (Sep 1972) 1851–72.CrossRefGoogle Scholar
  27. Merton, Robert, C., ‘An Intertemporal Capital Asset Pricing Model’, Econometrica, 41, no. 5 (Sep 1973) 867–87.CrossRefGoogle Scholar
  28. Mundell, R. A., Monetary Theory: Inflation, Interest and Growth in the World Economy, Pacific Palisades, California: Goodyear Publishing Co. Inc., 1971.Google Scholar
  29. Officer, L. H. and J. D. Willet, ‘The Covered-Arbitrage Schedule: A Critical Survey of Recent Developments’, Journal of Money Credit and Banking, II, no. 2 (May 1970) 247–57.CrossRefGoogle Scholar
  30. Pippenger, J., ‘Spat Rates, Forward Rates, and Interest Rate Differentials’, Journal of Money, Credit and Banking, III, no. 2 (May 1972).Google Scholar
  31. Porter, M., ‘A Theoretical and Empirical Framework for Analysing the Term Structure of Exchange Rate Expectations’, IMF Staff Papers, XVIII (1971) 613–45.CrossRefGoogle Scholar
  32. Prachowny, Martin F., ‘A Note on Interest Parity and the Supply of Arbitrage Funds’, Journal of Political Economy 78, no. 3 (May/June 1970) 540–45.CrossRefGoogle Scholar
  33. Samuelson, P. A., ‘Theoretical Notes on Trade Problems’, Review of Economics and Statistics XLVI, no. 2 (May 1964) 145–54.CrossRefGoogle Scholar
  34. Reprinted in J. E. Stiglitz (ed.)The Collected Scientific Papers of Paul A. Samuelson, vol. n, Cambridge, Mass.: M. I. T. Press, 1966. ch. 65, pp. 821–30.Google Scholar
  35. Samuelson, P. A., ‘The Mathematics of Speculative Price’, Mathematical Topics in Economic Theory and Computation, Society for Industrial and Applied Mathematics, 1972 1–42.Google Scholar
  36. Sidrauski, M., ‘Rational Choice and Patterns of Growth in a Monetary Economy’, American Economic Review, LVII, no. 2 (May 1967) 534–44.Google Scholar
  37. Solnik, Bruno H., European Capital Markets, Lexington, Mass.: Lexington Books, 1973.Google Scholar
  38. Solnik, B. H., ‘An Equilibrium Model of the International Capital Market’, Journal of Economic Theory, 8, no. 4 (Aug 1974) 500–24.CrossRefGoogle Scholar
  39. Stall, H. R., ‘Causes of Deviations from Interest Rate Parity’, Journal of Money, Credit and Banking, Iv, no. 1 (Feb 1972) 113–17.CrossRefGoogle Scholar
  40. Tobin, J., Essays in Economics, volume 1, Macroeconomics, Chicago: Markham Publishing Co., 1971.Google Scholar
  41. Tobin, J., ‘Friedman’s Theoretical Framework’, Journal of Political Economy, 80 no. 5(Sep/Oct 1972) 852–63.Google Scholar

Copyright information

© Graduate School of Business, University of Chicago 1977

Authors and Affiliations

  • Pentti J. K. Kouri

There are no affiliations available

Personalised recommendations