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The economic background [June 1995]

McDonald, Ronnie and Swales, Kim (1995) The economic background [June 1995]. Quarterly Economic Commentary, 20 (4). pp. 1-5. ISSN 0306-7866

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In our last review of the World Economy we focused on the implications of the continued volatility of floating exchange rates, and in particular the behaviour of the US dollar, for the reform of the International Monetary System. This topic proved to be one of the main talking points at the recent G7 meetings in Halifax, Canada. In this review we attempt to explain why when nominal exchange rates are left free to float they are generally very volatile and impart a similar degree of volatility into real exchange rates. In particular, we ask the question: can economic fundamentals explain the exchange rate behaviour we observe in foreign exchange markets, or is the behaviour simply a reflection of ill-informed speculation (what used to referred to in the UK as the 'gnomes of Zurich' effect)?