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

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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

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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File URL: http://www.upo.es/serv/bib/wps/econ0622.pdf
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Publisher Info
Paper provided by Universidad Pablo de Olavide, Departamento de Economía in its series Working Papers with number 06.22.

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

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

Other versions of this item:

Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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
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    Other versions:
  3. 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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  7. Bekaert, Geert & Gray, Stephen F., 1998. "Target zones and exchange rates:: An empirical investigation," Journal of International Economics, Elsevier, vol. 45(1), pages 1-35, June. [Downloadable!] (restricted)
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  13. 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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  20. Krugman, Paul & Miller, Marcus, 1992. "Why Have a Target Zone?," CEPR Discussion Papers 718, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  21. 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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  22. Ken West, 2003. "Monetary policy and the volatility of real exchange rates in New Zealand," Reserve Bank of New Zealand Discussion Paper Series DP2003/09, Reserve Bank of New Zealand. [Downloadable!]
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  27. Iannizzotto, Matteo & Taylor, Mark P, 1999. "The Target Zone Model, Non-linearity and Mean Reversion: Is the Honeymoon Really Over?," Economic Journal, Royal Economic Society, vol. 109(454), pages C96-110, March. [Downloadable!] (restricted)
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  29. repec:rus:hseeco:181565 is not listed on IDEAS
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  33. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February. [Downloadable!] (restricted)
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  34. 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)
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