We observed in the text that “fixed” exchange-rate systems can result not in absolutely fixed exchange rates but in narrow bands within which the exchange rate can move. For example, the gold points...

We observed in the text that “fixed” exchange-rate systems can result not in absolutely fixed exchange rates but in narrow bands within which the exchange rate can move. For example, the gold points (mentioned in footnote 18) produced such bands under a gold standard. (Typically those bands were on the order of plus or minus 1 percent of the “central” exchange parity.) To what extent would such bands for the exchange rate allow the domestic interest rate to move independently of a foreign rate? Show that the answer depends on the maturity or term of the interest rate. To help your intuition, assume plus or minus 1 percent bands for the exchange rate, and consider, alternatively, rates on three-month deposits, on six-month deposits, and on one-year deposits. With such narrow bands, would there be much scope for independence in ten-year loan rates?