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How to Run a Target Zone ? Age Old Lessons from an Austro-Hungarian Experiment

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  • Marc Flandreau

    (Centre for Finance and Development)

  • John Komlos

    (Department of Economics)

Abstract

This paper considers what we argue was the first experiment of an exchange rate band. This experiment took place in Austria-Hungary between 1896 and 1914. The rationale for introducing this policy rested on precisely those intuitions that modern target zone literature has recently emphasized: the band was designed to secure both exchange rate stability and monetary policy autonomy. However, unlike more recent experiences, such as the ERM, this policy was not undermined by credibility problems. In other words the episode provides us with an ideal testing ground for some important ideas in modern macroeconomics: specifically, can formal rules, when faithfully adhered to, provide policy makers with some advantages such as short term flexibility? First, we find that a credible band has a “microeconomic” influence on exchange rate stability. By reducing uncertainty, a credible fluctuation band improves the quality of expectations, a channel that has been neglected in the modern literature. Second, we show that the standard test of the basic target zone model is flawed and develop an alternative methodology. This enables us to understand why Austro-Hungarian policy makers were so upbeat about the merits of exchange rate target zones. We believe that these findings shed a new light on the economics of exchange rate bands.

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Paper provided by Sciences Po in its series Sciences Po publications with number n°556.

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Date of creation: Sep 2001
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Handle: RePEc:spo:wpmain:info:hdl:2441/323

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  1. Michael D. Bordo & Ronald MacDonald, 2001. "The Inter-War Gold Exchange Standard: Credibility and Monetary Independence," NBER Working Papers 8429, National Bureau of Economic Research, Inc.
  2. Lars E. O. Svensson, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 6(4), pages 119-144, Fall.
  3. Svensson, Lars E O, 1992. "Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates," CEPR Discussion Papers, C.E.P.R. Discussion Papers 742, C.E.P.R. Discussion Papers.
  4. Michael D. Bordo & Marc Flandreau, 2001. "Core, Periphery, Exchange Rate Regimes, and Globalization," Sciences Po publications n°3077, Sciences Po.
  5. Michael D. Bordo & Ronald MacDonald, 1997. "Violations of the `Rules of the Game' and the Credibility of the Classical Gold Standard, 1880-1914," NBER Working Papers 6115, National Bureau of Economic Research, Inc.
  6. repec:spo:wpecon:info:hdl:2441/622 is not listed on IDEAS
  7. Mark Blaug, 2001. "No History of Ideas, Please, We're Economists," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 15(1), pages 145-164, Winter.
  8. Paul Hallwood, C. & MacDonald, Ronald & Marsh, Ian W., 2000. "Realignment expectations and the US dollar, 1890-1897: Was there a 'Peso problem'?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 46(3), pages 605-620, December.
  9. Officer,Lawrence H., 2007. "Between the Dollar-Sterling Gold Points," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521038218.
  10. Koppl, Roger & Yeager, Leland B., 1996. "Big Players and Herding in Asset Markets: The Case of the Russian Ruble," Explorations in Economic History, Elsevier, Elsevier, vol. 33(3), pages 367-383, July.
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Cited by:
  1. António Portugal Duarte & João Sousa Andrade & Adelaide Duarte, 2013. "Exchange Rate Target Zones: A Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 27(2), pages 247-268, 04.
  2. Komlos, John & Flandreau, Marc, 2002. "Using ARIMA Forecasts to Explore the Efficiency of the Forward Reichsmark Market," Discussion Papers in Economics, University of Munich, Department of Economics 8, University of Munich, Department of Economics.
  3. Marc Flandreau, 2003. "Crises and Punishment : Moral Hazard and the pre-1914 international financial architecture," Sciences Po publications n°3742, Sciences Po.

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