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How to Run a Target Zone ? Age Old Lessons from an Austro-Hungarian Experiment

Author

Listed:
  • Marc Flandreau

    (Centre for Finance and Development)

  • John Komlos

    (Department of Economics)

Abstract

This paper considers what we argue was the first experiment of an exchange rate band. This experiment took place in Austria-Hungary between 1896 and 1914. The rationale for introducing this policy rested on precisely those intuitions that modern target zone literature has recently emphasized: the band was designed to secure both exchange rate stability and monetary policy autonomy. However, unlike more recent experiences, such as the ERM, this policy was not undermined by credibility problems. In other words the episode provides us with an ideal testing ground for some important ideas in modern macroeconomics: specifically, can formal rules, when faithfully adhered to, provide policy makers with some advantages such as short term flexibility? First, we find that a credible band has a “microeconomic” influence on exchange rate stability. By reducing uncertainty, a credible fluctuation band improves the quality of expectations, a channel that has been neglected in the modern literature. Second, we show that the standard test of the basic target zone model is flawed and develop an alternative methodology. This enables us to understand why Austro-Hungarian policy makers were so upbeat about the merits of exchange rate target zones. We believe that these findings shed a new light on the economics of exchange rate bands.

Suggested Citation

  • Marc Flandreau & John Komlos, 2001. "How to Run a Target Zone ? Age Old Lessons from an Austro-Hungarian Experiment," Sciences Po publications n°556, Sciences Po.
  • Handle: RePEc:spo:wpmain:info:hdl:2441/323
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    References listed on IDEAS

    as
    1. Mark Blaug, 2001. "No History of Ideas, Please, We're Economists," Journal of Economic Perspectives, American Economic Association, vol. 15(1), pages 145-164, Winter.
    2. E.O. Svensson, Lars, 1994. "Why exchange rate bands? : Monetary independence in spite of fixed exchange rates," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 157-199, February.
    3. Koppl, Roger & Yeager, Leland B., 1996. "Big Players and Herding in Asset Markets: The Case of the Russian Ruble," Explorations in Economic History, Elsevier, vol. 33(3), pages 367-383, July.
    4. Mark Blaug, 2001. "No History of Ideas, Please, We're Economists: Response," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 222-222, Fall.
    5. Michael D. Bordo & Ronald MacDonald, 1997. "Violations of the `Rules of the Game' and the Credibility of the Classical Gold Standard, 1880-1914," NBER Working Papers 6115, National Bureau of Economic Research, Inc.
    6. repec:spo:wpecon:info:hdl:2441/622 is not listed on IDEAS
    7. Michael D. Bordo & Marc Flandreau, 2003. "Core, Periphery, Exchange Rate Regimes, and Globalization," NBER Chapters,in: Globalization in Historical Perspective, pages 417-472 National Bureau of Economic Research, Inc.
    8. Lars E. O. Svensson, 1992. "An Interpretation of Recent Research on Exchange Rate Target Zones," Journal of Economic Perspectives, American Economic Association, vol. 6(4), pages 119-144, Fall.
    9. Paul Hallwood, C. & MacDonald, Ronald & Marsh, Ian W., 2000. "Realignment expectations and the US dollar, 1890-1897: Was there a 'Peso problem'?," Journal of Monetary Economics, Elsevier, vol. 46(3), pages 605-620, December.
    10. Bordo, Michael D. & MacDonald, Ronald, 2003. "The inter-war gold exchange standard: credibility and monetary independence," Journal of International Money and Finance, Elsevier, vol. 22(1), pages 1-32, February.
    11. Officer,Lawrence H., 2007. "Between the Dollar-Sterling Gold Points," Cambridge Books, Cambridge University Press, number 9780521038218.
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    Cited by:

    1. Michael D. Bordo & Marc Flandreau, 2003. "Core, Periphery, Exchange Rate Regimes, and Globalization," NBER Chapters,in: Globalization in Historical Perspective, pages 417-472 National Bureau of Economic Research, Inc.
    2. Komlos, John & Flandreau, Marc, 2002. "Using ARIMA Forecasts to Explore the Efficiency of the Forward Reichsmark Market," Discussion Papers in Economics 8, University of Munich, Department of Economics.
    3. repec:spo:wpecon:info:hdl:2441/622 is not listed on IDEAS
    4. Marc Flandreau, 2003. "Crises and Punishment : Moral Hazard and the pre-1914 international financial architecture," Sciences Po publications n°3742, Sciences Po.
    5. António Portugal Duarte & João Sousa Andrade & Adelaide Duarte, 2013. "Exchange Rate Target Zones: A Survey Of The Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 27(2), pages 247-268, April.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • N32 - Economic History - - Labor and Consumers, Demography, Education, Health, Welfare, Income, Wealth, Religion, and Philanthropy - - - U.S.; Canada: 1913-

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