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Soft exchange rate bands and speculative attacks: theory and evidence from the ERM since August 1993

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Author Info
Leonardo Bartolini
Alessandro Prati

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Abstract

We present a model of a "soft" exchange rate target zone and interpret it as a stylized description of the post-August 1993 ERM. Our central bank targets a moving average of the current and past exchange rates, rather than the exchange rate's current level, thus allowing the rate to move within wide margins in the short run, but within narrow margins in the long run. For realistic parameters, soft target zones are significantly less vulnerable to speculative attacks than "hard" target zones. These predictions are consistent with the ERM's experience and the abatement of speculative pressure in European markets since the bands' widening in 1993.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 43.

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Date of creation: 1998
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Handle: RePEc:fip:fednsr:43

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Keywords: Foreign exchange rates ; European Monetary System (Organization);

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  1. Robert P. Flood & Andrew K. Rose, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," NBER Working Papers 4503, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Labhard, Vincent & Wyplosz, Charles, 1996. "The New EMS: Narrow Bands inside Deep Bands," American Economic Review, American Economic Association, vol. 86(2), pages 143-46, May. [Downloadable!] (restricted)
  3. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August. [Downloadable!] (restricted)
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  4. Bartolini, Leonardo & Bodnar, Gordon M., 1992. "Target zones and forward rates in a model with repeated realignments," Journal of Monetary Economics, Elsevier, vol. 30(3), pages 373-408, December. [Downloadable!] (restricted)
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  5. Dumas, Bernard & Svensson, Lars E. O., 1994. "How long do unilateral target zones last?," Journal of International Economics, Elsevier, vol. 36(3-4), pages 467-481, May. [Downloadable!] (restricted)
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  6. Delgado, Francisco & Dumas, Bernard, 1993. "Monetary contracting between central banks and the design of sustainable exchange-rate zones," Journal of International Economics, Elsevier, vol. 34(3-4), pages 201-224, May. [Downloadable!] (restricted)
  7. Flood, Robert P. & Rose, Andrew K. & Mathieson, Donald J., 1991. "An empirical exploration of exchange-rate target-zones," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 35(1), pages 7-65, January. [Downloadable!] (restricted)
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  8. Leonardo Bartolini & Alessandro Prati, 1997. "Soft versus hard targets for exchange rate intervention," Economic Policy, CEPR, CES, MSH, vol. 12(24), pages 13-52, 04. [Downloadable!] (restricted)
  9. Gilles, Christian & LeRoy, Stephen F, 1991. "Econometric Aspects of the Variance-Bounds Tests: A Survey," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 4(4), pages 753-91. [Downloadable!] (restricted)
  10. Lars E.O. Svensson, 1990. "The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk," NBER Working Papers 3466, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Svensson, Lars E O, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-44, Fall. [Downloadable!] (restricted)
  12. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August. [Downloadable!] (restricted)
  13. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, April.
  14. Klein, Michael W., 1992. "Big effects of small interventions: The informational role of intervention in exchange rate policy," European Economic Review, Elsevier, vol. 36(4), pages 915-924, May. [Downloadable!] (restricted)
  15. Hull, John & White, Alan, 1993. "One-Factor Interest-Rate Models and the Valuation of Interest-Rate Derivative Securities," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(02), pages 235-254, June. [Downloadable!]
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