EXCHANGE-RATE AND INTEREST-RATE POLARIZATION

The relationship between the polarization phenomenon in foreign exhang e markets and a similar regularity in interest rate differentials is c onsidered. In the case of perfect substitutability and of perfect fore sight, both polarizations would be perfectly complementary. Risk premi a and forecast errors, however, might induce some degree of substituta bility between the two concepts. Throughout almost the entire EMS expe rience, in France and Italy both phenomena appear to be equivalent. At the end of the 80s, however, interest rate polarization has surged at the expense of exchange rate polarization. In fact, a bias in estimat es was found to explain this recent behaviour.