Levin, J. H.
December 1979
Economic Journal;Dec79, Vol. 89 Issue 356, p921
Academic Journal
The purpose of this note is to demonstrate that, in the absence of sterilisation policies, fixed exchange rate systems are unstable when (a) interest rates have a larger impact on interest payment flows than on sustained capital flows, and (b) goods markets adjust sluggishly. In order to understand this result, consider a small open economy, which faces a fixed world price for its imports and a fixed interest rate on foreign securities. Its goods market is characterised by a partial adjustment of economic activity to any gap between aggregate demand and production, but domestic interest rates adjust instantaneously to help clear the financial sector.[1] The latter two assumptions, of course, correspond exactly to those employed in the asset approach to exchange, rate determination under a floating exchange rate system.[2].


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