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Target Zones and Exchange Rate Dynamics

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Paul R. Krugman

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Abstract

This paper develops a highly simplified model of exchange rate behavior within the band under a target zone regime. It shows that the expectation that authorities will defend the band exerts a stabilizing effect on exchange rate behavior within the band, even when the authorities are not actively intervening. The extent of stabilization can be related in a straightforward way to three factors: the sensitivity of the current exchange rate to expected depreciation, the volatility of the process driving exchange rate "fundamentals", and the credibility of the commitment by authorities to defend the target zone.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2481.

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Date of creation: Jan 1988
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Handle: RePEc:nbr:nberwo:2481

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This page was last updated on 2009-11-20.

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