The role of policy variables

Policy variables have a dual impact on regime efficiency. First, market variables are themselves influenced by policy variables. Second, policy variables can also have a direct influence on regime efficiency. Because only short-run regime efficiency is studied, basic policies (such as the mint value of a country's currency and sterilization of reserves flows) are not considered. Two short-term policies of interest are discount-rate policy and exchange-market intervention.

Discount-rate policy

It was found in section 3 of chapter 14 that market interest rates were not favorable for regime efficiency. Why was this so? Underlying the market rates in London and New York were Bank Rate (the Bank of England's discount rate) and the Federal Reserve Bank of New York discount rate, respectively. Monthly series of these central-bank rates are constructed as averages of daily observations. As shown in table 14.3, the Bank Rate – Federal Reserve Bank of New York discount-rate differential, denoted as Ibr − Idr, comparable to the market-rate differential (Iuk − Ius), is positive for 83 percent of the months (53 out of 64) when the pound is weak (and, perversely, for all ten months when the pound is strong). Also, for RS < RM, the mean value of (Ibr − Idr) is over three-fifths of a percentage point per year – ostensibly quite conducive to regime efficiency.