Monetary Policy Independence Under Floating Exchange Rates : Some Pleasant Results

Under a floating exchange rate and integrated financial markets an optimizing central bank acting under discretion to achieve domestic objectives generates a positive co-movement between the domestic and the foreign interest rate in a small open economy. A high degree of positive co-movement between the domestic and foreign interest rate does not indicate lack of monetary policy independence but reflects the constraints under which an optimizing central bank operates in an economy with close financial ties to the rest of the world