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Target Zones with Limited Reserves


  • Paul Krugman
  • Julio Rotemberg


Like a fixed exchange rate, a target zone system may be subject to speculative attacks when the reserves of the central bank are limited. This paper analyzes such speculative attacks and their implications; it shows that the recently developed "smooth pasting" model of target zones should be viewed as a special case that emerges only when reserves are sufficiently large. The paper then uses the target zone framework to resolve a seeming paradox in predicting speculative attacks on a gold standard, arguing that such a standard may best be viewed as the boundary between one-sided target zones.

Suggested Citation

  • Paul Krugman & Julio Rotemberg, 1990. "Target Zones with Limited Reserves," NBER Working Papers 3418, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:3418
    Note: ITI IFM

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    References listed on IDEAS

    1. Miller, M. & Weller, P., 1988. "Solving Stochastic Saddlepoint Systems: A Qualitative Treatment With Economic Applications," The Warwick Economics Research Paper Series (TWERPS) 309, University of Warwick, Department of Economics.
    2. Svensson, Lars E. O., 1991. "Target zones and interest rate variability," Journal of International Economics, Elsevier, vol. 31(1-2), pages 27-54, August.
    3. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
    4. Froot, Kenneth A. & Obstfeld, Maurice, 1991. "Exchange-rate dynamics under stochastic regime shifts : A unified approach," Journal of International Economics, Elsevier, vol. 31(3-4), pages 203-229, November.
    5. Svensson, Lars E. O., 1991. "The term structure of interest rate differentials in a target zone : Theory and Swedish data," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 87-116, August.
    6. Flood, Robert P & Garber, Peter M, 1983. "A Model of Stochastic Process Switching," Econometrica, Econometric Society, vol. 51(3), pages 537-551, May.
    7. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
    8. Robert P. Flood & Peter M. Garber, 1989. "The Linkage Between Speculative Attack and Target Zone Models of Exchange Rates," NBER Working Papers 2918, National Bureau of Economic Research, Inc.
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