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How tight should one's hands be tied? Fear of floating and credibility of exchange regimes

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Author Info
Jesús Rodríguez López () (Department of Economics, Universidad Pablo de Olavide)
Hugo Rodríguez Mendizábal () (Department of Economics, Universidad Autónoma de Barcelona)

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Abstract

The literature on exchange regimes has recently observed that officially self-declared free floaters strongly intervene their nominal exchange rates to maintain them within some unannounced bands. In this paper, we provide an explanation for this behavior, labeled by Calvo and Reinhart (2002) as fear of floating. First, we analyze the linkages between the credibility of the exchange regime, the volatility of the exchange rate and the band width of fluctuation. Second, the model is used to understand the reduction in volatility experienced by most ERM countries after their target zones were widened on August 1993. Finally, solving the model for a subgame perfect equilibrium, fear of floating can be viewed as the credible choice of a finite non-zero band

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Publisher Info
Paper provided by Universidad Pablo de Olavide, Departamento de Economía in its series Working Papers with number 06.03.

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Length: 36 pages
Date of creation: Mar 2006
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Handle: RePEc:pab:wpaper:06.03

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Related research
Keywords: Fear of floating target zones exchange rate arrangements credibility

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Francisco Ledesma-Rodriguez & Manuel Navarro-Ibanez & Jorge Perez-Rodriguez & Simon Sosvilla-Rivero, 2000. "On the Credibility of the Irish Pound in the EMS," The Economic and Social Review, Economic and Social Studies, vol. 31(2), pages 151-172. [Downloadable!]
  2. Carmen M. Reinhart, 2000. "Mirage of Floating Exchange Rates," American Economic Review, American Economic Association, vol. 90(2), pages 65-70, May. [Downloadable!] (restricted)
  3. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "The Mirage of Fixed Exchange Rates," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 73-96, Fall. [Downloadable!] (restricted)
    Other versions:
  4. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring. [Downloadable!] (restricted)
  5. Bertola, Giuseppe & Svensson, Lars E O, 1993. "Stochastic Devaluation Risk and the Empirical Fit of Target-Zone Models," Review of Economic Studies, Blackwell Publishing, vol. 60(3), pages 689-712, July. [Downloadable!] (restricted)
    Other versions:
  6. Svensson, Lars E O, 1994. "Fixed Exchange Rates as a Means to Price Stability: What Have We Learned?," CEPR Discussion Papers 872, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  7. Maurice Obstfeld, 1997. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Bekaert, Geert, 1995. "The Time Variation of Expected Returns and Volatility in Foreign-Exchange Markets," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(4), pages 397-408, October.
  9. Labhard, Vincent & Wyplosz, Charles, 1996. "The New EMS: Narrow Bands inside Deep Bands," American Economic Review, American Economic Association, vol. 86(2), pages 143-46, May. [Downloadable!] (restricted)
  10. E.O. Svensson, Lars, 1994. "Why exchange rate bands? : Monetary independence in spite of fixed exchange rates," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 157-199, February. [Downloadable!] (restricted)
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  11. Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June. [Downloadable!]
  12. Giavazzi, Francesco & Pagano, Marco, 1986. "The Advantages of Tying One's Hands: EMS Discipline and Central Bank Credibility," CEPR Discussion Papers 135, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  13. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May. [Downloadable!] (restricted)
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  14. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Ayuso, Juan & Restoy, Fernando, 1996. "Interest rate parity and foreign exchange risk premia in the ERM," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 369-382, June. [Downloadable!] (restricted)
  16. Ball, Clifford A. & Roma, Antonio, 1993. "A jump diffusion model for the European monetary system," Journal of International Money and Finance, Elsevier, vol. 12(5), pages 475-492, October. [Downloadable!] (restricted)
  17. Jesús Rodríguez López & Hugo Rodríguez Mendizábal, 2002. "On the Choice of an Exchange Regime: Target Zones Revisited," Economic Working Papers at Centro de Estudios Andaluces E2002/10, Centro de Estudios Andaluces. [Downloadable!]
  18. Svensson, Lars E O, 1991. "The Simplest Test of Target Zone Credibility," CEPR Discussion Papers 493, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  19. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, vol. 19(1-2), pages 47-66, August. [Downloadable!] (restricted)
  20. Svensson, Lars E O, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-44, Fall. [Downloadable!] (restricted)
  21. Gomez-Puig, Marta & Montalvo, JoseG., 1997. "A new indicator to assess the credibility of the EMS," European Economic Review, Elsevier, vol. 41(8), pages 1511-1535, August. [Downloadable!] (restricted)
  22. Svensson, L.E., 1990. "The Foreign Exchange Risk Premium in a Target Zone with Devaluation Risk," Papers 475, Stockholm - International Economic Studies.
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  23. Jess Rodr?uez L?ez & Hugo Rodr?uez Mendiz?al, 2002. "On the Choice of an Exchange Rate Regime: Target Zones Revisited," UFAE and IAE Working Papers 518.02, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC). [Downloadable!]
  24. Bekaert, Geert, 1994. "Exchange rate volatility and deviations from unbiasedness in a cash-in-advance model," Journal of International Economics, Elsevier, vol. 36(1-2), pages 29-52, February. [Downloadable!] (restricted)
  25. Geert Bekaert & Stephen F. Gray, 1999. "Target Zones and Exchange Rates: An Empirical Investigation," NBER Working Papers 5445, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  26. Stockman, Alan C., 1999. "Choosing an exchange-rate system," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1483-1498, October. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jesús Rodríguez-López & Hugo Rodriguez Mendizabal, 2006. "How Tight Should One's Hands be Tied? Fear of Floating and the Credibility of Exchange Rate Regimes," Topics in Macroeconomics, Berkeley Electronic Press, vol. 6(1), pages 1401-1401. [Downloadable!] (restricted)
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