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When Do Target Zones Work? An Examination of Exchange Rate Targeting as a Device for Coordinating Economic Policies

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  • A.J. Hallet

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Abstract

With the European Exchange Rate Mechanism, the Louvre Accord and the Bretton Woods system, policy makers have tried to use exchange rate targeting as a means of improving economic performance. However, while initially successful, all three regimes eventually collapsed. This paper asks what makes target zones work? We show that coordination can be achieved by having all countries play a noncooperative game in which each has to take account of some of the aims of others in addition to their own. If policies are built around exchange rate targeting, this means the target path should be a projected equilibrium exchange rate, updated and amended to include the latest information on realisations of foreign as well as domestic targets. That would provide the necessary conditions for induced coordination. They are not sufficient for successful targeting however, since there is no guarantee that the coordination will be strong enough for the gains to be distributed in an incentive compatible way. Copyright Kluwer Academic Publishers 1998

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Bibliographic Info

Article provided by Springer in its journal Open Economies Review.

Volume (Year): 9 (1998)
Issue (Month): 2 (April)
Pages: 115-138

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Handle: RePEc:kap:openec:v:9:y:1998:i:2:p:115-138

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Web page: http://www.springerlink.com/link.asp?id=100323

Related research

Keywords: exchange rate management; policy coordination; incentive structures;

References

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  1. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  2. Miller, M. & Weller, P., 1988. "Exchange Rate Bands And Realignments In A Stationary Stochastic Setting," The Warwick Economics Research Paper Series (TWERPS) 317, University of Warwick, Department of Economics.
  3. Hallett, A. J. Hughes, 1984. "Optimal stockpiling in a high-risk commodity market the case of copper," Journal of Economic Dynamics and Control, Elsevier, vol. 8(2), pages 211-238, November.
  4. Cooper, Richard N, 1969. "Macroeconomic Policy Adjustment in Interdependent Economies," The Quarterly Journal of Economics, MIT Press, vol. 83(1), pages 1-24, February.
  5. Feldstein, Martin, 1988. "Rethinking International Economic Coordination," Oxford Economic Papers, Oxford University Press, vol. 40(2), pages 205-19, June.
  6. Hughes Hallett, A. J., 1986. "Policy design in asymmetrically dependent economies," Journal of Economic Dynamics and Control, Elsevier, vol. 10(1-2), pages 51-57, June.
  7. Sachs, Jeffrey, 1986. "The Uneasy Case for Greater Exchange Rate Coordination," American Economic Review, American Economic Association, vol. 76(2), pages 336-41, May.
  8. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  9. Bertola, G. & Svensson, L.E., 1990. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," Papers 481, Stockholm - International Economic Studies.
  10. Hallet, A. J. Hughes, 1994. "On the imperfect substitutability of policy regimes : Exchange rate targetting vs policy coordination," Economics Letters, Elsevier, vol. 44(1-2), pages 159-164.
  11. Edison, Hali J. & Marquez, Jaime R. & Tryon, Ralph W., 1987. "The structure and properties of the Federal Reserve Board Multicountry Model," Economic Modelling, Elsevier, vol. 4(2), pages 115-315, April.
  12. Driver, Rebecca & Wren-Lewis, Simon, 1996. "How Robust are FEERs?," Discussion Papers 9606, Exeter University, Department of Economics.
  13. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, December.
  14. Hallett, A. J. Hughes, 1992. "Target zones and international policy coordination : The contrast between the necessary and sufficient conditions for success," European Economic Review, Elsevier, vol. 36(4), pages 893-914, May.
  15. Gilles Oudiz & Jeffrey Sachs, 1984. "Macroeconomic Policy Coordination among the Industrial Economies," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(1), pages 1-76.
  16. Jocelyn Horne & Paul R. Masson, 1988. "Scope and Limits of International Economic Cooperation and Policy Coordination," IMF Staff Papers, Palgrave Macmillan, vol. 35(2), pages 259-296, June.
  17. Hughes Hallett, A J, 1993. "Exchange Rates and Asymmetric Policy Regimes: When Does Exchange Rate Targeting Pay?," Oxford Economic Papers, Oxford University Press, vol. 45(2), pages 191-206, April.
  18. Currie, David & Holtham, Gerald & Hughes, Gordon, 1989. "The Theory and Practice of International Policy Coordination: Does Coordination Pay?," CEPR Discussion Papers 325, C.E.P.R. Discussion Papers.
  19. Edison, Hali J. & Miller, Marcus H. & Williamson, John, 1987. "On evaluating and extending the target zone proposal," Journal of Policy Modeling, Elsevier, vol. 9(1), pages 199-224.
  20. Joseph E. Gagnon & Ralph W. Tryon, 1992. "Stochastic behavior of the world economy under alternative policy regimes," International Finance Discussion Papers 428, Board of Governors of the Federal Reserve System (U.S.).
  21. Currie, David & Wren-Lewis, Simon, 1989. "Evaluating Blueprints for the Conduct of International Macro Policy," American Economic Review, American Economic Association, vol. 79(2), pages 264-69, May.
  22. Holtham, Gerald & Hughes Hallett, Andrew, 1987. "International Policy Cooperation and Model Uncertainty," CEPR Discussion Papers 190, C.E.P.R. Discussion Papers.
  23. Currie, David & Wren-Lewis, Simon, 1989. "An appraisal of alternative blueprints for international policy coordination," European Economic Review, Elsevier, vol. 33(9), pages 1769-1785, December.
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Cited by:
  1. Creel, Jerome & Capoen, Fabrice & Cussy, Pascal & Lenoble-Liaud, Helene, 2003. "How to manage financial shocks: Intra-European vs. international monetary coordination," Journal of Macroeconomics, Elsevier, vol. 25(4), pages 431-455, December.
  2. Hughes Hallett, Andrew, 2005. "In Praise of Fiscal Restraint and Debt Rules. What the Euro Zone Might Do Now," CEPR Discussion Papers 5043, C.E.P.R. Discussion Papers.
  3. Hughes Hallett, Andrew & Weymark, Diana, 2002. "Government Leadership and Central Bank Design," CEPR Discussion Papers 3395, C.E.P.R. Discussion Papers.
  4. Fabrice Capoen & Jérôme Creel, 2007. "Efficiency of stability-oriented institutions: the European case," Sciences Po publications N°2007-06, Sciences Po.
  5. Pascal Cussy & Hélène Lenoble-Liaud & Fabrice Capoen & Jérôme Creel, 2000. "How to manage speculative shocks : intra-european vs. international monetary coordination," Sciences Po publications N° 2000-01, Sciences Po.
  6. Andrew Hughes Hallett, 2004. "Post-Thatcher Fiscal Strategies in the U.K.: An Interpretation," CESifo Working Paper Series 1372, CESifo Group Munich.
  7. repec:spo:wpecon:info:hdl:2441/2978 is not listed on IDEAS

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