Exchange rate flexibility is commonly justified as an efficient method for adjusting the trade balance to some desirable net international capital flow. In this orthodox view, fluctuations in a country's terms of trade or its saving-investment balance would continually upset its balance of...

In the international capital market, interest rates would seem to be natural shock absorbers for balancing currency risk associated with expected inflation or differential taxation. Under a floating exchange rate, however, short-term interest rates in each national money market behave as if...