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Flexible Exchange Rates in the 1970's

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  • Jacob A. Frenkel

Abstract

The 1970's witnessed the dramatic evolution of the international monetary system from a regime of pegged exchange rates into a regime of flexible rates. This paper surveys the key issues and lessons from the experience with floating rates during the1970's. The main orientation is empirical and the analysis is based on the experience of the three exchange rates: the Dollar/Pound, the Dollar/French Franc, and the Dollar/DM. The first issue that is being examined is the efficiency of the foreign exchange market and the degree of exchange rates volatility. The analytical framework emphasizes that exchange rates are the prices of assets that are traded in organized markets and are strongly influenced by expectations about future events. The principal finding is that the behavior of the foreign exchange market has been broadly consistent with the efficient market hypothesis. The second issue concerns the relationship between exchange rates and interest rates. It is shown that during the inflationary period of the 1970's, exchange rates and interest rates were positively correlated. This positive association is interpreted in terms of the role played by inflationary expectations. The analysis draws a distinction between expected and unexpected changes in interest rates; it is demonstrated that changes in exchange rates are strongly associated with the unexpected component of changes in the interest rates. The third issue concerns the relationship between exchange rates and prices. It is shown that the experience of the 1970'sdoes not support the prediction of the simple version of the purchasing power parity theory and that the deviations from purchasing power parities can be characterized by a first-order autoregressive process. These deviations are then interpreted.

Suggested Citation

  • Jacob A. Frenkel, 1980. "Flexible Exchange Rates in the 1970's," NBER Working Papers 0450, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0450
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    References listed on IDEAS

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    1. Frenkel, Jacob A & Mussa, Michael L, 1980. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence," American Economic Review, American Economic Association, vol. 70(2), pages 374-381, May.
    2. Jacques R. Artus & John H. Young, 1979. "Fixed and Flexible Rates: A Renewal of The Debate," NBER Working Papers 0367, National Bureau of Economic Research, Inc.
    3. Douglas R. Mudd, 1979. "Do rising U.S. interest rates imply a stronger dollar?," Review, Federal Reserve Bank of St. Louis, vol. 61(Jun), pages 9-13.
    4. Paul R. Milgrom, 1978. "Rational Expectations," Discussion Papers 406, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    5. Frenkel, Jacob A & Levich, Richard M, 1977. "Transaction Costs and Interest Arbitrage: Tranquil versus Turbulent Periods," Journal of Political Economy, University of Chicago Press, vol. 85(6), pages 1209-1226, December.
    6. Frenkel, Jacob A., 1979. "Further evidence on expectations and the demand for money during the German hyperinflation," Journal of Monetary Economics, Elsevier, vol. 5(1), pages 81-96, January.
    7. Rodriguez, Carlos Alfredo, 1980. "The Role of Trade Flows in Exchange Rate Determination: A Rational Expectations Approach," Journal of Political Economy, University of Chicago Press, vol. 88(6), pages 1148-1158, December.
    8. Frankel, Jeffrey A, 1979. "On the Mark: A Theory of Floating Exchange Rates Based on Real Interest Differentials," American Economic Review, American Economic Association, vol. 69(4), pages 610-622, September.
    9. Kouri, Pentti J K, 1976. " The Exchange Rate and the Balance of Payments in the Short Run and in the Long Run: A Monetary Approach," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 280-304.
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    Cited by:

    1. Michael R. Darby, 1981. "Does purchasing power parity work?," Proceedings, Federal Reserve Bank of San Francisco, issue 5, pages 136-173.
    2. Peltonen, Tuomas A. & Sager, Michael, 2009. "Productivity shocks and real exchange rate: a reappraisal," Working Paper Series 1046, European Central Bank.
    3. Louka T. Katseli, 1984. "Real Exchange Rates in the 1970s," NBER Chapters, in: Exchange Rate Theory and Practice, pages 281-334, National Bureau of Economic Research, Inc.

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