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International Investment and Interest Rate Linkages under Flexible Exchange Rates

  • Pentti J. K. Kouri

Abstract

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.

Keywords

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.

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Copyright information

© Graduate School of Business, University of Chicago 1977

Authors and Affiliations

  • Pentti J. K. Kouri

There are no affiliations available

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