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Limited Reserves and the Optimal Width of an Exchange Rate Target zone

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  • Simon Broome

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    (National University of Ireland, Maynooth)

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    Abstract

    This paper analyses the stabilising properties of an exchange rate target zone when the stock of available reserves is limited. In these circumstances it is reasonable to suppose that the optimal bandwidth is affected by the expected lifetime of the zone. Our analysis uses Sutherland's (1995) target zone model to assess the importance of the expected lifetime in determining the optimal width of the zone. We find that the expected lifetime tends to widen the optimal bandwidth considerably but unless the stock of initial reserves is small and/or the fundamentals drift large, the extra lifetime bought is small in percentage terms.

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    Bibliographic Info

    Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n1220803.

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    Length: 34 pages
    Date of creation: Aug 2003
    Date of revision:
    Handle: RePEc:may:mayecw:n1220803

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    Related research

    Keywords: Stabilisation policy; exchange rate crises; optimal target zones;

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    References

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    1. Miller, Marcus & Weller, Paul, 1990. "Exchange Rate Bands with Price Inertia," CEPR Discussion Papers 421, C.E.P.R. Discussion Papers.
    2. 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.
    3. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
    4. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    5. Klein, Michael W, 1990. "Playing with the Band: Dynamic Effects of Target Zones in an Open Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(4), pages 757-72, November.
    6. Klein, Michael W. & Marion, Nancy P., 1997. "Explaining the duration of exchange-rate pegs," Journal of Development Economics, Elsevier, vol. 54(2), pages 387-404, December.
    7. Beetsma, Roel M. W. J. & van der Ploeg, Frederick, 1998. "Macroeconomic stabilization and intervention policy under an exchange rate band," Journal of International Money and Finance, Elsevier, vol. 17(2), pages 339-353, April.
    8. Krugman, Paul & Miller, Marcus, 1992. "Why Have a Target Zone?," CEPR Discussion Papers 718, C.E.P.R. Discussion Papers.
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