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The optimal degree of exchange rate flexibility: A target zone approach

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  • Jesús Rodríguez López

    ()
    (Department of Economics, Universidad Pablo de Olavide)

  • Hugo Rodríguez Mendizábal

    ()
    (Department of Economics, Universidad Autónoma de Barcelona)

Abstract

This paper presents a benchmark model that rationalizes the choice of the degree of exchange rate flexibility. We show that the monetary authority may gain efficiency by reducing volatility of both the exchange rate and the interest rate at the same time. Furthermore, the model is consistent with some known stylized facts in the empirical literature on target zones that previous models were not able to generate jointly, namely, the positive relation between the exchange rate and the interest rate differential, the degree of non-linearity of the function linking the exchage rate to fundamentals and the shape of the exchange rate stochastic distribution.

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Bibliographic Info

Paper provided by Universidad Pablo de Olavide, Department of Economics in its series Working Papers with number 06.22.

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Length: 34 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:pab:wpaper:06.22

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Keywords: Target zones; exchange rate agreements; monetary policy; time consistency.;

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