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Title

How tight should one's hands be tied? Fear of floating and credibility of exchange rate regimes

AuthorsRodríguez Mendizábal, Hugo ; Rodríguez-López, Jesús
KeywordsFear of floating
Target zones
Exchange rate arrangements
Rational expectations, credibility
Issue Date21-Oct-2003
SeriesUFAE and IAE Working Papers
593.03
AbstractThis paper analyzes the linkages between the credibility of a target zone regime, the volatility of the exchange rate, and the width of the band where the exchange rate is allowed to fluctuate. These three concepts should be related since the band width induces a trade-off between credibility and volatility. Narrower bands should give less scope for the exchange rate to fluctuate but may make agents perceive a larger probability of realignment which by itself should increase the volatility of the exchange rate. We build a model where this trade-off is made explicit. The model is used to understand the reduction in volatility experienced by most EMS countries after their target zones were widened on August 1993. As a natural extension, the model also rationalizes the existence of non-official, implicit target zones (or fear of floating), suggested by some authors.
URIhttp://hdl.handle.net/10261/1825
Appears in Collections:(IAE) Informes y documentos de trabajo
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