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Target Zones with Limited Reserves

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  • Paul Krugman
  • Julio Rotemberg

Abstract

Like a fixed exchange rate, a target zone system may be subject to speculative attacks when the reserves of the central bank are limited. This paper analyzes such speculative attacks and their implications; it shows that the recently developed "smooth pasting" model of target zones should be viewed as a special case that emerges only when reserves are sufficiently large. The paper then uses the target zone framework to resolve a seeming paradox in predicting speculative attacks on a gold standard, arguing that such a standard may best be viewed as the boundary between one-sided target zones.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3418.

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Date of creation: Aug 1990
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Handle: RePEc:nbr:nberwo:3418

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  1. Lars E. O. Svensson, 1990. "Target Zones and Interest Rate Variability," IMF Working Papers 90/31, International Monetary Fund.
  2. Robert P. Flood & Peter M. Garber, 1981. "A Model of Stochastic Process Switching," NBER Working Papers 0626, National Bureau of Economic Research, Inc.
  3. Miller, Marcus & Weller, Paul, 1989. "Solving Stochastic Saddlepoint Systems: A Qualitative Treatment with Economic Applications," CEPR Discussion Papers 308, C.E.P.R. Discussion Papers.
  4. Froot, Kenneth A. & Obstfeld, Maurice, 1991. "Exchange-rate dynamics under stochastic regime shifts : A unified approach," Journal of International Economics, Elsevier, vol. 31(3-4), pages 203-229, November.
  5. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
  6. Robert P. Flood & Peter M. Garber, 1989. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," NBER Working Papers 2918, National Bureau of Economic Research, Inc.
  7. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
  8. Lars E.O. Svensson, 1990. "The Term Structure of Interest Rate Differentials in a Target Zone: Theory and Swedish Data," NBER Working Papers 3374, National Bureau of Economic Research, Inc.
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