tailieunhanh - INTEREST RATES AND EXCHANGE RATES - WHAT IS THE RELATIONSHIP?

First, it is worth remembering that the reduction in reserve demand is in large part the result of the failure of reserves to pay interest. The incentive to economize on reserves was greater when inflation made nominal interest rates much higher than they are today. But even at current interest rates, banks continue to find ways to avoid holding reserves. 13 A falling demand for reserves is far from inevitable if the opportunity cost of holding reserve balances at a central bank is reduced by achieving price stability or by paying interest on reserves. Second, we saw above that in general, a. | Interest Rates and Exchange Rates What is the Relationship By Craig s. Hakkio During much of the 1970s . interest rates and the foreign exchange value of the dollar moved in opposite directions. This relationship was particularly pronounced from 1976 to 1979 when short-term interest rates doubled while the trade-weighted value of the dollar fell 17 percent. In the 1980s however the relationship between interest rates and the exchange rate appears to be considerably different. Indeed for much of this period . interest rates and the value of the dollar have been positively correlated. A key question is whether the apparent change in the relationship between interest rates and exchange rates represents a significant structural change in their linkages or whether the change in the relationship can be explained by using standard economic models. The answer to this question has important implications for policymakers. Interest rates and exchange rates are crucial elements in the transmission of monetary and Craig s. Hakkio is a senior economist at the Federal Reserve Bank of Kansas City. J. Gregg Whittaker assistant economist at the bank assisted in the preparation of the article. fiscal policy actions to economic activity. If the channels through which policy actions affect the economy have been altered policymakers may find the design of policy to be more difficult and the consequences of policy actions more unpredictable. Thus models of interest rate and exchange rate linkages that worked well during the 1970s may not be appropriate in the 1980s. This article argues that much of the apparent instability in the interest rate-exchange rate relationship can be readily explained in terms of standard economic models. The change from a negative correlation between interest rates and exchange rates in the 1970s to a positive correlation in the 1980s is due to changes in the relative importance of factors underlying interest rate and exchange rate movements. Thus .