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Limited Reserves and the Optimal Width of an Exchange Rate Target zone

  • Simon Broome

    ()

    (National University of Ireland, Maynooth)

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    This paper analyses the stabilising properties of an exchange rate target zone when the stock of available reserves is limited. In these circumstances it is reasonable to suppose that the optimal bandwidth is affected by the expected lifetime of the zone. Our analysis uses Sutherland's (1995) target zone model to assess the importance of the expected lifetime in determining the optimal width of the zone. We find that the expected lifetime tends to widen the optimal bandwidth considerably but unless the stock of initial reserves is small and/or the fundamentals drift large, the extra lifetime bought is small in percentage terms.

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    File URL: http://repec.maynoothuniversity.ie/mayecw-files/N1220803.pdf
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    Paper provided by Department of Economics, Finance and Accounting, National University of Ireland - Maynooth in its series Economics, Finance and Accounting Department Working Paper Series with number n1220803.

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    Length: 34 pages
    Date of creation: Aug 2003
    Date of revision:
    Handle: RePEc:may:mayecw:n1220803
    Contact details of provider: Postal: Maynooth, Co. Kildare
    Phone: 353-1-7083728
    Fax: 353-1-7083934
    Web page: http://www.maynoothuniversity.ie/economics-finance-and-accounting

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    1. Miller M. & Weller, P., 1990. "Exchange Rate Bands With Price Inertia," The Warwick Economics Research Paper Series (TWERPS) 337, University of Warwick, Department of Economics.
    2. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
    3. Beetsma, Roel & van der Ploeg, Frederick, 1994. "Macroeconomic Stabilization and Intervention Policy Under an Exchange Rate Band," CEPR Discussion Papers 925, C.E.P.R. Discussion Papers.
    4. Dumas, Bernard & Svensson, Lars E. O., 1994. "How long do unilateral target zones last?," Journal of International Economics, Elsevier, vol. 36(3-4), pages 467-481, May.
    5. Klein, Michael W, 1990. "Playing with the Band: Dynamic Effects of Target Zones in an Open Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(4), pages 757-72, November.
    6. Michael W. Klein & Nancy P. Marion, 1994. "Explaining the Duration of Exchange-Rate Pegs," NBER Working Papers 4651, National Bureau of Economic Research, Inc.
    7. Krugman, Paul & Miller, Marcus, 1993. "Why have a target zone?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 38(1), pages 279-314, June.
    8. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
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