Interest Rate Differentials and Foreign Exchange Expectations on the Money and Capital Market

In the past, Austrian monetary authorities have kept fluctuations in the schilling-mark relation within narrow limits. Under certain assumptions, the "credibility" of this foreign exchange rate policy can be measured by using data on nominal interest rate differentials between Austria and West Germany. The analysis of the yield of instruments with a maturity of from one month to ten years allows the evaluation of the "credibility" of foreign exchange rate expectations over these time horizons. The empirical results show that credibility has increased since 1988 on the money market, and since 1989 on the long-term market. According to the data, real interest rates in Austria and Germany have not converged. The components of the real interest rate gap indicate that the capital and goods markets in both countries are not completely integrated.