The Two-tier foreign exchange market and the conduct of monetary policy: The Belgian case during Bretton-Woods era

This paper attempts to better understand the monetary policy decisions under the Belgian two-tier foreign exchange market during the Bretton-Woods system. Whereas this type of market organisation aimed at insulating the domestic currency from (speculative) capital flows, it is questioned whether monetary authorities did (or not) really pay attention to the free market when setting the monetary policy interest rate in practice. Using a Taylor-rule type approach, it is shown that the volatility of the spread between the two segments of the foreign exchange market has played a growing role in the interest rate dynamics over time. Moreover, a Markov switching model applied to the data provides evidence of two separate periods towards the collapse of the Bretton-Woods System, during which the monetary policy concerns have gradually changed.