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Dynamic Inconsistency and Exchange-Rate Target Zones: A Welfare Analysis

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  • Zhen Zhu

Abstract

This paper examines the welfare implications of different exchange-rate systems, especially an exchange-rate target-zone system, in a context of monetary policy making and dynamic inconsistency. It is shown that when there is uncertainty, there is a trade-off between commitment to a rule and discretion. A free-floating exchange-rate system may have the same loss function values in terms of price and output fluctuations as that of a target zone. However, a target-zone system may be more attractive since there is less exchange-rate fluctuation. Returning to a fixed-rate system may be worse since it may bring about larger welfare losses especially when supply shocks dominate. [F31, E52]

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  • Zhen Zhu, 1997. "Dynamic Inconsistency and Exchange-Rate Target Zones: A Welfare Analysis," International Economic Journal, Taylor & Francis Journals, vol. 11(1), pages 15-38.
    • Handle: RePEc:taf:intecj:v:11:y:1997:i:1:p:15-38
    DOI: 10.1080/10168739700000002
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    1. Rasekhi, Saeed & Rastgar, Majid, 2016. "Policy Time-Inconsistency: A Comparison of Managed Floating Exchange Rate and Controlled Exchange Rate Regimes," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 11(4), pages 351-373, October.

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