Target Zone Primer

This paper surveys methods and models used in the target zone literature. The following areas are covered: rationale for stochastic modelling; Ito's Lemma and stochastic differential equations; the basic target zone model; the flexible price monetary model; simple real exchange rate zones; sticky-price target zones; Uhlenbeck-Ornstein target zone model; empirical evidence on target zones; structural exchange rate models; purchasing power parity; expectations; government intervention policy; target zone realignments; learning and credibility; interest rate effects; linkages with other exchange rate phenomena; speculative attacks, stochastic process switching; rational bubbles; gold standard paradoxes and target zone optimization