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Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates

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  • Lars E.O. Svensson

Abstract

The paper argues that the reason real world fixed exchange rate regimes usually have finite bands instead of completely fixed exchange rates between realignments is that exchange rate bands, counter to the textbook result, give central banks some monetary independence, even with free international capital mobility. The nature and amount of monetary independence is specified, informally, and in a formal model, and quantified with Swedish krona data. Altogether the amount of monetary independence appears sizable. For instance, an increase in the Swedish krona band from zero to about plus or minus two percent may reduce the krona interest rate's standard deviation by about one-half.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4207.

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Date of creation: Nov 1992
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Publication status: published as Journal of Monetary Economics, vol. 33, 1994, pp. 157-199
Handle: RePEc:nbr:nberwo:4207

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  1. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  2. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination In Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  3. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," NBER Working Papers 3685, National Bureau of Economic Research, Inc.
  4. Hans Lindberg & Lars E.O. Svensson & Paul Soderlind, 1991. "Devaluation Expectations: The Swedish Krona 1982-1991," NBER Working Papers 3918, National Bureau of Economic Research, Inc.
  5. Miller, Marcus & Weller, Paul, 1991. "Exchange Rate Bands with Price Inertia," Economic Journal, Royal Economic Society, vol. 101(409), pages 1380-99, November.
  6. Krugman, Paul & Miller, Marcus, 1993. "Why have a target zone?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 38(1), pages 279-314, June.
  7. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
  8. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
  9. Svensson, Lars E O, 1990. "Target Zones and Interest Rate Variability," CEPR Discussion Papers 372, C.E.P.R. Discussion Papers.
  10. Goodfriend, Marvin, 1987. "Interest rate smoothing and price level trend-stationarity," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 335-348, May.
  11. Daniel Gros, 1990. "Stabilization Policy with Bands," IMF Working Papers 90/49, International Monetary Fund.
  12. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, May.
  13. Alan Sutherland, . "Monetary and Real Shocks and the Optimal Target Zone," Discussion Papers 92/7, Department of Economics, University of York.
  14. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  15. Beetsma, R.M.W.J. & Ploeg, F. van der, 1992. "Exchange rate bands and optimal monetary accomodation under a dirty float," Discussion Paper 1992-13, Tilburg University, Center for Economic Research.
  16. Bertola, G. & Svensson, L.E., 1990. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," Papers 481, Stockholm - International Economic Studies.
  17. Ben Bernanke & Frederic Mishkin, 1992. "Central Bank Behavior and the Strategy of Monetary Policy: Observations From Six Industrialized Countries," NBER Working Papers 4082, National Bureau of Economic Research, Inc.
  18. 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.
  19. Willem H. Buiter & Richard C. Marston, 1985. "International Economic Policy Coordination," NBER Books, National Bureau of Economic Research, Inc, number buit85-1, May.
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