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Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates

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  • Svensson, Lars E O

Abstract

The paper argues that real world fixed exchange rate regimes usually have finite bands instead of completely fixed exchange rates between realignments because exchange rate bands, contrary to the textbook result, give central banks some monetary independence even with free international capital mobility. The nature and amount of monetary independence is specified, informally and in a formal model, and quantified with Swedish krona data. The amount of monetary independence thus achieved appears sizeable. For instance, an increase in the Swedish krona band from zero to about +2% may reduce the krona interest rate's standard deviation by about 1/2.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 742.

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Date of creation: Dec 1992
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Handle: RePEc:cpr:ceprdp:742

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Keywords: Interest Rates; Mean Reversion; Monetary Policy; Target Zones;

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References

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  1. Bertola, Giuseppe & Svensson, Lars E O, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 689-712, July.
  2. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  3. Svensson, Lars E O, 1990. "Target Zones and Interest Rate Variability," CEPR Discussion Papers 372, C.E.P.R. Discussion Papers.
  4. Miller M. & Weller, P., 1990. "Exchange Rate Bands With Price Inertia," The Warwick Economics Research Paper Series (TWERPS) 337, University of Warwick, Department of Economics.
  5. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond.
  6. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination In Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  7. Hans Lindberg & Lars E.O. Svensson & Paul Soderlind, 1991. "Devaluation Expectations: The Swedish Krona 1982-1991," NBER Working Papers 3918, National Bureau of Economic Research, Inc.
  8. Robert P. Flood & Andrew K. Rose & Donald J. Mathieson, 1990. "An Empirical Exploration of Exchange Rate Target-Zones," NBER Working Papers 3543, National Bureau of Economic Research, Inc.
  9. Krugman, P. & Miller, M., 1992. "Why Have a Target Zone?," The Warwick Economics Research Paper Series (TWERPS) 394, University of Warwick, Department of Economics.
  10. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and predicted realignments: the FF/DM exchange rate during the EMS," International Finance Discussion Papers 395, Board of Governors of the Federal Reserve System (U.S.).
  11. Ben Bernanke & Frederic Mishkin, 1992. "Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 183-238 National Bureau of Economic Research, Inc.
  12. Sutherland, Alan, 1995. "Monetary and real shocks and the optimal target zone," European Economic Review, Elsevier, vol. 39(1), pages 161-172, January.
  13. Buiter,Willem H. & Marston,Richard C., 1986. "International Economic Policy Coordination," Cambridge Books, Cambridge University Press, number 9780521337809, December.
  14. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  15. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  16. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1.
  17. Beetsma, R.M.W.J. & Ploeg, F. van der, 1992. "Exchange rate bands and optimal monetary accomodation under a dirty float," Discussion Paper 1992-13, Tilburg University, Center for Economic Research.
  18. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  19. Daniel Gros, 1990. "Stabilization Policy With Bands," IMF Working Papers 90/49, International Monetary Fund.
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