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Forward Rates, Interest Rates, and Expectations Under Alternative Exchange Rate Regimes

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  • PETER B. KENEN

Abstract

A model comprising spot and forward foreign exchange markets and a domestic credit market is used to examine the trade‐off between volatility in the nominal exchange rate and domestic interest rate. It also shows how a slowly crawling spot rate can raise interest rate volatility and the amplitude of reserve flows. Finally, the paper extends a finding by Driskill and McCafferty that the exchange rate effects of external shocks are differently affected by the responsiveness of speculation to expected profits; high responsiveness makes the spot exchange rate more sensitive to foreign financial shocks but less sensitive to trade balance shocks.

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  • Peter B. Kenen, 1985. "Forward Rates, Interest Rates, and Expectations Under Alternative Exchange Rate Regimes," The Economic Record, The Economic Society of Australia, vol. 61(3), pages 654-666, September.
    • Handle: RePEc:bla:ecorec:v:61:y:1985:i:3:p:654-666
    DOI: 10.1111/j.1475-4932.1985.tb02020.x
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    References listed on IDEAS

    as
    1. Dornbusch, Rudiger, 1982. "PPP Exchange-Rate Rules and Macroeconomic Stability," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 158-165, February.
    2. Mathieson, Donald J., 1976. "Is there an optimal crawl?," Journal of International Economics, Elsevier, vol. 6(2), pages 183-202, May.
    3. Driskill, Robert & McCafferty, Stephen, 1982. "Spot and forward rates in a stochastic model of the foreign exchange market," Journal of International Economics, Elsevier, vol. 12(3-4), pages 313-331, May.
    4. S. C. Tsiang, 1959. "The Theory of Forward Exchange and Effects of Government Intervention on the Forward Exchange Market," IMF Staff Papers, Palgrave Macmillan, vol. 7(1), pages 75-106, April.
    5. Gross, E.M.A. & Hogan, W.P., 1982. "Short Term Management of the Australian Exchange Rate, 1977-82," Working Papers 66, University of Sydney, School of Economics.
    6. Brunner, Karl & Meltzer, Allan H., 1976. "The Phillips curve," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 1-18, January.
    7. McCallum, Bennett T, 1977. "The Role of Speculation in the Canadian Forward Exchange Market: Some Estimates Assuming Rational Expectations," The Review of Economics and Statistics, MIT Press, vol. 59(2), pages 145-151, May.
    8. McCormick, Frank, 1977. "A multiperiod theory of forward exchange," Journal of International Economics, Elsevier, vol. 7(3), pages 269-282, August.
    9. Eaton, Jonathan & Turnovsky, Stephen J, 1983. "Exchange Risk, Political Risk, and Macroeconomic Equilibrium," American Economic Review, American Economic Association, vol. 73(1), pages 183-189, March.
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