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Exchange Rate Bands And Realignments In A Stationary Stochastic Setting

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  • MILLER, M.
  • WELLER, P.

Abstract

The extent which exchange rate management can coexist with an independent monetary policy is examined in the context of a model with exchange rate bands. Using a Dornbusch model in which stochastic shocks are added to the Phillips curve, we analyze the implications of assuming that the monetary authorities follow certain simple rules for realigning the band when fundamentals have drifted too far from equilibrium. Assuming that information about whether the bands is to be defended or there is to be a realignment is revealed at the point when the exchange rate hits the edge of the band, we show how the path of the exchange rate can be completely characterized in terms of the solution to a second order nonlinear differential equation - together with jumps in the rate at the edge of the band, which satisfy a zero profit arbitrage condit.

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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 317.

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Length: 18 pages
Date of creation: 1988
Date of revision:
Handle: RePEc:wrk:warwec:317

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Keywords: exchange rate ; management ; monetary policy;

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Cited by:
  1. Pesaran, M.H. & Samiei, H., 1993. "Limited-Dependaent Rational Expectations Models with Future Expectations," Cambridge Working Papers in Economics, Faculty of Economics, University of Cambridge 9321, Faculty of Economics, University of Cambridge.
  2. M. Hashem Pesaran & Francisco J. Ruge-Murcia, 1996. "Limited-dependent rational expectations models with jumps," Discussion Paper / Institute for Empirical Macroeconomics, Federal Reserve Bank of Minneapolis 111, Federal Reserve Bank of Minneapolis.
  3. Michael Hu & Christine Jiang & Christos Tsoukalas, 2004. "The volatility impact of the European monetary system on member and non-member currencies," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 14(5), pages 313-325.
  4. Svensson, Lars E O, 1990. "Target Zones and Interest Rate Variability," CEPR Discussion Papers, C.E.P.R. Discussion Papers 372, C.E.P.R. Discussion Papers.
  5. Dean Corbae & Chris Neely & Paul Weller, 1998. "Endogenous realignments and the sustainability of a target," Working Papers, Federal Reserve Bank of St. Louis 1994-009, Federal Reserve Bank of St. Louis.
  6. Kathryn M. Dominguez & Peter B. Kenen, 1991. "Intramarginal Intervention in the EMS and the Target-Zone Model of Exchange-Rate Behavior," NBER Working Papers 3670, National Bureau of Economic Research, Inc.
  7. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, Elsevier, vol. 33(1-2), pages 21-40, August.
  8. Giuseppe Bertola & Lars E.O. Svensson, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," NBER Working Papers 3576, National Bureau of Economic Research, Inc.
  9. A.J. Hallet, 1998. "When Do Target Zones Work? An Examination of Exchange Rate Targeting as a Device for Coordinating Economic Policies," Open Economies Review, Springer, Springer, vol. 9(2), pages 115-138, April.

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