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

Peter Kenen

The Economic Record, 1985, vol. 61, issue 3, 654-666

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.

Date: 1985
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