The Behavior of Bond Yields Across Exchange-Rate Regimes and the Integration of Capital Markets

In Europe as elsewhere, the debate over the appropriate exchange-rate regime continues. One of the major sources of contention is the effect of the regime on the economies involved. Did the move to floating exchange rates alter the behavior of important economic and financial variables within countries? Did it alter relationships among countries? If so, to what degree and in what direction? On the simplest theoretical level the answers to these questions depend on whether the variables of interest are nominal or real. According to this line of reasoning, the exchange-rate regime, the conditions affecting a nominal variable, should only affect other nominal variables and not real variables. In short, the regime should be neutral. Empirical evidence on this issue, however, has been mixed.1 The dichotomy between nominal and real appears to be preserved for many, but not all, macroeconomic variables. Exchange rates themselves are the most notable exception, with the increased variability in nominal exchange rates under the float apparently carrying over into increased variability in real exchange rates (Mussa, 1986). This, in turn, has raised questions about other international financial relations. McKinnon (1990), for example, has argued that the uncertainty engendered by suc