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Stabilization Policy, Fixed Exchange Rates and Target Zones

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  • Alogoskoufis, George

Abstract

This paper provides a theoretical evaluation of two of the most influential recent proposals for international monetary reform, namely McKinnon's standard with fixed exchange rates and Williamson's target zones. The focus is on the implications of the proposals for short-run stabilization policy. The results suggest that in a first-best world where all countries have recourse to both monetary and fiscal policy, the McKinnon standard would be not only desirable, but also feasible, in the sense that if world monetary policy is set optimally, there is no incentive for individual economies to engage in exchange rate management. In the absence of fiscal flexibility, even when world monetary policy is set optimally, exchange rate management becomes necessary to counteract the distortions arising from country-specific supply shocks. The nominal exchange rate flexibility inherent in the target zones proposal is then a necessary part of the optimal (second-best) world monetary system. The analysis, however, suggests no role for either explicit bands or nominal income targets.

Suggested Citation

  • Alogoskoufis, George, 1989. "Stabilization Policy, Fixed Exchange Rates and Target Zones," CEPR Discussion Papers 304, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:304
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    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=304
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    Cited by:

    1. George Alogoskoufis & Richard Portes, 1990. "International Costs and Benefits from EMU," NBER Working Papers 3384, National Bureau of Economic Research, Inc.

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