This paper highlights exchange rate movements and adjustment in financial markets. This paper develops a model of portfolio behavior in which it is assumed that market participants act as if they always expected exchange rates to move in line with expected inflation differentials. In the solution of this model, exchange rate movements are determined by real interest rate differentials and the cumulated balance of external payments. Two important empirical features distinguish this model from most other models based on the asset-market approach to exchange rate determination. The paper gives evidence that comparisons between these estimates and alternative models broadly support the model developed here. A principal conclusion is that interest rate differentials do have a clearer short-run relationship to exchange rate changes than to exchange rate levels.
This paper focuses on theoretical and policy issues posed by financial integration among industrial countries since the mid-1950s. The problems of measuring international financial integration and of estimating its trend over the years are also explored. The role of the Euro-dollar market, as a major financial intermediary that channels short-term funds between the money markets of the industrial countries, is examined first. An econometric analysis of factors influencing the Euro-dollar interest rate indicates that its movements are dominated by conditions in the United States and suggests a high degree of integration between the US and Euro-dollar capital markets. However, the results also lend some support to the view that the Euro-dollar rate is influenced by conditions in Europe, particularly by bursts of speculation. Since neither sterilization policies nor intervention in capital movements is likely to be entirely successful, highly integrated economies might also tend to determine their interest rates partly in the light of interest rate developments overseas.