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Vol. 61, No. 4
Posted 1980-04-01

Flexible Exchange Rates in the 1970s

by Jacob A. Frenkel

Jacob Frenkel sets forth the way in which the asset market or monetary approach to exchange rate determination helps to explain flexible exchange rates, particularly the observed volatility in exchange rates and the relation between exchange rates and both domestic and foreign interest rates and price levels. Within this framework, Frenkel highlights the central role of expectations, particularly expectations about future inflation, in determining exchange rates. An explanation of the volatility of exchange rates is aided by the view that these rates are a financial variable whose value is sensitive to expectations about future developments and is capable of quickly incorporating new information about these developments. The central role of inflation expectations suggests, according to Frenkel, an “intimate connection between monetary policy and exchange rate policy” and imposes a “unique responsibility on the monetary authorities in affecting the rate of exchange.”