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Monetary Contracting Between Central Banks and the Design of SustainableExchange-Rate Zones

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  • Francisco Delgado
  • Bernard Dumas

Abstract

An exchange-rate system is a set of contracts which commits central banks to intervene in the foreign-exchange market. The design features of the system include: the rules of intervention, the limits placed on exchange rates and the "crisis scenario" which describes possible transitions to new regimes in case one central bank runs out of reserves or borrowing capacity. This paper considers the various trade-offs one faces in designing an exchange-rate system. Svensson (1989) has already analyzed the degree of variability in the exchange rate, the interest rate and the fundamentals. But the tradeoff also pertains to the amount of reserves which the central banks must have on hand in order to forestall a speculative attack and make the system sustainable. The amount of reserves needed depends crucially on the assured crisis scenario.

Suggested Citation

  • Francisco Delgado & Bernard Dumas, 1990. "Monetary Contracting Between Central Banks and the Design of SustainableExchange-Rate Zones," NBER Working Papers 3440, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3440
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    Cited by:

    1. Bernard Dumas & Lars Peter Jennergren & Bertil Näslund, 1992. "Currency option pricing in credible target zones," Working Papers hal-00611601, HAL.
    2. Lera, Sandro Claudio & Sornette, Didier, 2016. "Quantitative modelling of the EUR/CHF exchange rate during the target zone regime of September 2011 to January 2015," Journal of International Money and Finance, Elsevier, vol. 63(C), pages 28-47.
    3. Bartolini, Leonardo & Prati, Alessandro, 1999. "Soft exchange rate bands and speculative attacks: theory, and evidence from the ERM since August 1993," Journal of International Economics, Elsevier, vol. 49(1), pages 1-29, October.
    4. Buiter, Willem H. & Pesenti, Paolo A., 1990. "Rational Speculative Bubbles In An Exchange Rate Target Zone," Economic Research Papers 268490, University of Warwick - Department of Economics.
    5. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, vol. 33(1-2), pages 21-40, August.
    6. Dumas, Bernard & Peter Jennergren, L. & Naslund, Bertil, 1995. "Realignment risk and currency option pricing in target zones," European Economic Review, Elsevier, vol. 39(8), pages 1523-1544, October.
    7. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    8. Giuseppe Bertola & Lars E. O. Svensson, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(3), pages 689-712.
    9. 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.
    10. Antoine Magnier, 1992. "Théorie des zones cibles et fonctionnement du SME," Économie et Prévision, Programme National Persée, vol. 104(3), pages 87-113.
    11. Dominique Hachette & Fernando Ossa & Francisco Rosende, 1996. "Aspectos Monetarios y Macroeconómicos de la Integración," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(98), pages 153-183.
    12. Martínez-García, Enrique, 2015. "On the sustainability of exchange rate target zones with central parity realignments," Economics Letters, Elsevier, vol. 134(C), pages 86-89.
    13. Svensson, Lars E. O., 1991. "The term structure of interest rate differentials in a target zone : Theory and Swedish data," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 87-116, August.
    14. Giancarlo Marini & Giovanni Piersanti, 2012. "Models of Speculative Attacks and Crashes in International Capital Markets," CEIS Research Paper 245, Tor Vergata University, CEIS, revised 24 Jul 2012.
    15. Kontulainen, Jarmo & Lehmussaari, Olli-Pekka & Suvanto, Antti, 1990. "The Finnish experience on maintaining a currency band in the 1980s," Bank of Finland Research Discussion Papers 26/1990, Bank of Finland.
    16. Gabauer, David, 2021. "Dynamic measures of asymmetric & pairwise connectedness within an optimal currency area: Evidence from the ERM I system," Journal of Multinational Financial Management, Elsevier, vol. 60(C).
    17. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    18. Maria Aguirre & Paul Kroopkin, 1997. "Exchange rate dynamics in integrated markets," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 3(3), pages 269-280, August.

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