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The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

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  • Hertrich, Markus

Abstract

In the aftermath of the recent financial crisis, the central banks of small open economies such as the Czech National Bank and the Swiss National Bank (SNB) both implemented a unilateral one-sided exchange rate target zone vis-a-vis the euro currency to counteract deflationary pressures. Recently, the SNB abandoned its minimum exchange rate regime of CHF 1.20 per euro, arguing that after having analyzed the costs and benefits of this non-standard exchange rate policy measure, it was no longer sustainable. This paper proposes a model that allows central banks to estimate ex-ante the costs of implementing and maintaining a unilateral one-sided target zone and to monitor these costs during the period where it is enforced. The model also offers central banks a tool to identify the right timing for the discontinuation of a minimum exchange rate regime. An empirical application to the Swiss case shows the actual size of these costs and reveals that these costs would have been substantial without the abandonment of the minimum exchange rate regime, which accords with the official statements of the SNB.

Suggested Citation

  • Hertrich, Markus, 2015. "The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone," MPRA Paper 67839, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:67839
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    More about this item

    Keywords

    Foreign exchange reserves; minimum exchange rate; reflected geometric Brownian motion; target zone costs; Swiss National Bank;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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