The Exchange Rate, Interest Rates and the Current Balance ln a Forward-Looking Model

Andrew Gurney

National Institute Economic Review, 1988, vol. 125, 40-45

Abstract: In March this year, after a year in which policy appeared to be aimed at achieving stability against EMS currencies, the pound was allowed to rise sharply in response to large capital inflows. As with many fluctuations in exchange rates, this development was puzzling in that the prospects for the balance of payments suggested that the rise in sterling would not prove sustainable. On the other hand, high UK interest rates, particularly in relation to those available in EMS countries, provided some rationale for a temporary rise. This note uses a simple forward-looking equation for the exchange rate to illustrate the implications of alternative paths for interest rates and the balance of payments. A number of simulations are presented to illustrate the key elements of this approach.

Date: 1988
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