Monetary autonomy and fixed exchange rates not together

How major currencies have moved against INR ( as on 16 June 2011) (Source: ratesfx.com)

US Dollar

Exchange rate behaviour

perception

Thinking about inflation

Inflationary expectations and actual inflationary experience

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Interest rate parity theorem

The forward rate in foreign exchange integrates the money market and the exchange market

Deviations from interest rate parity create possibilities of arbitrage – the

The prices of internationally traded commodities should be the same in

every country.

If the spot exchange rate between two currencies starts in equilibrium, any change in the differential rate of

inflation between them tends to be offset over the long term by an equal

Deviations from PPP tend to persist over fairly long periods of time. It is

these deviations that create economic

Exchange rate behaviour

Possible answer to question posed on the previous slide

Exchange rate behaviour

12

interest rate is relatively low )

What factors would you consider when you try to form a view on the likely

Factors to look at

Central bank intervention

Fixed exchange rates, open capital markets and monetary autonomy

Fixed exchange rates and free capital flows do not go together ( the crisis in Europe, 1992, and the East Asian crisis, late nineties)

Fundamental analysis ( modeling based on macro-economic factors )