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Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates

  • Lars E.O. Svensson

The paper argues that the reason real world fixed exchange rate regimes usually have finite bands instead of completely fixed exchange rates between realignments is that exchange rate bands, counter to the textbook result, give central banks some monetary independence, even with free international capital mobility. The nature and amount of monetary independence is specified, informally, and in a formal model, and quantified with Swedish krona data. Altogether the amount of monetary independence appears sizable. For instance, an increase in the Swedish krona band from zero to about plus or minus two percent may reduce the krona interest rate's standard deviation by about one-half.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4207.

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Date of creation: Nov 1992
Date of revision:
Publication status: published as Journal of Monetary Economics, vol. 33, 1994, pp. 157-199
Handle: RePEc:nbr:nberwo:4207
Note: IFM
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Lindberg, H. & Svensson, L.E. & Soderlind, P., 1991. "Devaluation Expectations: the Swedish Krona 1982-1991," Papers 495, Stockholm - International Economic Studies.
  2. Svensson, Lars E O, 1990. "Target Zones and Interest Rate Variability," CEPR Discussion Papers 372, C.E.P.R. Discussion Papers.
  3. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  4. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond.
  5. Sutherland, Alan, 1995. "Monetary and real shocks and the optimal target zone," European Economic Review, Elsevier, vol. 39(1), pages 161-172, January.
  6. Willem H. Buiter & Richard C. Marston, 1985. "International Economic Policy Coordination," NBER Books, National Bureau of Economic Research, Inc, number buit85-1, December.
  7. Bertola, Giuseppe & Svensson, Lars E O, 1991. "Stochastic Devaluation Risk and the Empirical Fit of Target Zone Models," CEPR Discussion Papers 513, C.E.P.R. Discussion Papers.
  8. Beetsma, R.M.W.J. & van der Ploeg, F., 1992. "Exchange rate bands and optimal monetary accomodation under a dirty float," Discussion Paper 1992-13, Tilburg University, Center for Economic Research.
  9. Krugman, Paul & Miller, Marcus, 1992. "Why Have a Target Zone?," CEPR Discussion Papers 718, C.E.P.R. Discussion Papers.
  10. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
  11. Gilles Oudiz & Jeffrey Sachs, 1985. "International Policy Coordination in Dynamic Macroeconomic Models," NBER Chapters, in: International Economic Policy Coordination, pages 274-330 National Bureau of Economic Research, Inc.
  12. Ben Bernanke & Frederic Mishkin, 1992. "Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 183-238 National Bureau of Economic Research, Inc.
  13. Donald J. Mathieson & Robert P. Flood & Andrew K. Rose, 1991. "An Empirical Exploration of Exchange Rate Target-Zones," IMF Working Papers 91/15, International Monetary Fund.
  14. Daniel Gros, 1990. "Stabilization Policy with Bands," IMF Working Papers 90/49, International Monetary Fund.
  15. Miller, Marcus & Weller, Paul, 1991. "Exchange Rate Bands with Price Inertia," Economic Journal, Royal Economic Society, vol. 101(409), pages 1380-99, November.
  16. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and Predicted Realignments: The FF/DM Exchange Rate During the EMS," NBER Working Papers 3685, National Bureau of Economic Research, Inc.
  17. Paul Krugman & Marcus Miller, 1992. "Exchange Rate Targets and Currency Bands," NBER Books, National Bureau of Economic Research, Inc, number krug92-1, December.
  18. Lindbecg, H. Soderlind, P., 1992. "Target Zone Models and the Intervention Policy; The Swedish Case," Papers 496, Stockholm - International Economic Studies.
  19. Backus, David & Driffill, John, 1986. "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," CEPR Discussion Papers 124, C.E.P.R. Discussion Papers.
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