Target zones for exchange rates and policy changes
AbstractWe extend a target zone model to allow for occasional changes in the policy regime which change the stochastic process driving fundamentals. A scenario we have in mind is that macroeconomic policy alternates between relatively tight and loose regimes. A key implication of our analysis is that occurrences which have the appearance of speculative attacks on a currency may be associated with market perceptions of a policy regime switch having taken place. This applies both to a sudden weakening and strengthening of a currency. Our model provides an explanation, based on fundamentals, why large changes in the exchange rate might be associated with no discernible contemporaneous change in the fundamental. Therefore the model provides an explanation for this phenomenon that is an alternative to explanations based on self-fulfilling expectations. Compared with most other models of target zones, other than those relying on intra-marginal intervention, this model is better able to reproduce key features of empirical distributions of exchange rates within the band. The distribution generated by our model has more mass at the centre and less at the edges of the band than is the case for most other models.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of International Money and Finance.
Volume (Year): 25 (2006)
Issue (Month): 6 (October)
Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/30443
Other versions of this item:
- John Driffill (Birkbeck College) & Martin Sola (UTDT), 2005. "Target Zones for Exchange Rates and Policy Changes," Department of Economics Working Papers 2005-03, Universidad Torcuato Di Tella.
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- JEL - Labor and Demographic Economics - - - - -
- Cla - Mathematical and Quantitative Methods - - - - -
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