Thus, we introduced a flexible exchange rate system within the fixed exchange rate system.
"It is clear that we must evolve towards a more flexible exchange rate system that will allow us to withstand shocks," Mr. Sarkozy said in his address.
"As Tim Geithner said, it is important for the United States and the world economy that our major trading partners operate with a flexible exchange rate system," the official said, "in which market forces determine the value of exchange rates.
Later, in prepared remarks for the meeting's closing ceremony, Mr. Geithner praised the Chinese for moving toward a more flexible exchange rate system and loosening controls on moving capital in and out of the country.
Therefore, the exchange rate affects interest rates significantly when a flexible exchange rate system is introduced.
Further, in a flexible exchange rate system, interest rate variations are related to capital flows and exchange rate movements.
Further, under the flexible exchange rate system, the foreign exchange market could play significant role in interest rate variations.
The Mundell-Fleming model (Fleming 1962; Mundell 1963) of open economy macroeconomics testifies that the monetary policy of a small open economy becomes effective when the economy adopts a flexible exchange rate system.
The significant effect of the exchange rate on interest rate during the post-global recession period (when the flexible exchange rate system was operational) suggests that, apart from the domestic factors, some external factors (typically transmitted through the exchange rate channel) could play a role in the variation of interest rates.
That requires policy reforms to reduce China's massive saving, which drives its current-account surplus, and a more flexible exchange-rate system.
