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

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  • Leonardo Bartolini
  • Alessandro Prati

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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Bibliographic Info

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. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
  2. Lewis, Karen K, 1995. "Occasional Interventions to Target Rates," American Economic Review, American Economic Association, vol. 85(4), pages 691-715, September.
  3. Lars E. O. Svensson, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-144, Fall.
  4. Donald J. Mathieson & Robert P. Flood & Andrew K. Rose, 1991. "An Empirical Exploration of Exchange Rate Target-Zones," IMF Working Papers 91/15, International Monetary Fund.
  5. Flood, R.P. & Rose, A.K., 1992. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," Papers 529, Stockholm - International Economic Studies.
  6. Dumas, B. & Svensson, E.O., 1991. "How Long Do Unilateral Target Zones Last?," Papers 509, Stockholm - International Economic Studies.
  7. 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.
  8. Michael W. Klein & Karen K. Lewis, 1991. "Learning About Intervention Target Zones," NBER Working Papers 3674, National Bureau of Economic Research, Inc.
  9. 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.
  10. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1.
  11. C. Gilles & S.F. Leroy, 1990. "Econometric Aspects of the Variance-Bound Tests: A Survey," Carleton Economic Papers 90-07, Carleton University, Department of Economics, revised 1991.
  12. 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.
  13. 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.
  14. Gordon M. Bodnar & Leonardo Bartolini, 1992. "Target Zones and Forward Rates in a Model with Repeated Realignments," IMF Working Papers 92/22, International Monetary Fund.
  15. 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.
  16. 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.
  17. 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.
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Cited by:
  1. repec:onb:oenbwp:y:2004:i:1:b:1 is not listed on IDEAS
  2. Lundbergh, Stefan & Terasvirta, Timo, 2006. "A time series model for an exchange rate in a target zone with applications," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 579-609.
  3. M. Frömmel & G. Garabedian & F. Schobert, 2009. "Monetary Policy Rules in Central and Eastern European Countries: Does the Exchange Rate Matter?," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 09/611, Ghent University, Faculty of Economics and Business Administration.
  4. Eleftheriou, Maria & Gerdesmeier, Dieter & Roffia, Barbara, 2006. "Monetary policy rules in the pre-EMU era: Is there a common rule?," Working Paper Series 0659, European Central Bank.
  5. Nissanke, Machiko, 2003. "Revenue Potential of the Currency Transaction Tax for Development Finance: A Critical Appraisal," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  6. Inci, Ahmet Can, 2005. "ERM effects on currency spot and futures markets," Global Finance Journal, Elsevier, vol. 16(2), pages 145-163, December.
  7. Miller, J. Isaac, 2011. "Testing the bounds: Empirical behavior of target zone fundamentals," Economic Modelling, Elsevier, vol. 28(4), pages 1782-1792, July.

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