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By Michael Beenstock

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Some components of 'leads and lags' may be attributable to such factors. However, if a unit of domestic currency is sold forward rather than spot, it will be purchased by an arbitrageur who in any case would have sold spot in order to complete the implied covered transaction. There may have been some confusion in the literature concerning the insulation of the domestic monetary system from the balance of payments and capital markets, in particular if the spot rate is flexible. 28 The Balance of Payments The standard argument runs that if domestic interest rates rise and the exchange rate is floating only the ownership of existing domestic currency positions net will alter.

It is the presence of risk and the aversion to risk that bounds the scale of investment decisions in generating finite elasticities. This forms the basis for a world where yields may actually differ, which of course would conflict with the infinite elasticity assumption. Therefore the elasticity of speculation would tend to be finite. More troublesome is the elasticity of the covered interest arbitrage schedule where exchange risks are zero. If indeed there were no other risks, one would expect an infinitely elastic arbitrage schedule.

Subsequently, the price level will The Long Run 45 fall and during the adjustment process the balance of payments will tend to improve both on the current and capital accounts. 33iii states that in the long run full employment will be achieved. 17 where real wages are assumed to adjust to eliminate excess demand in the labour market. Alternatively, the ·natural' rate of unemployment will be established as in Friedman [ 1968]. 33 imply that when the exchange rate is fixed the monetary authorities are ultimately responsible for the health of the balance of payments, that the price level or the rate of inflation is largely dependent upon overseas prices and that the economy will have a tendency towards full employment in the steady state.

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