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...

This paper proposes a tractable and realistic nonlinear model of exchange rate dynamics, and argues that its predictions are consistent with available empirical evidence on exchange rate and interest differential behavior in real-life target zones. In our model, the exchange rate fluctuates...

The optimal escape from a liquidity trap involves generating private-sector expectations of a higher future price level and higher future inflation. This lowers the real interest rate and reduces the recession during the liquidity trap. The problem, emphasized by Krugman, is that central-bank...

A credible target zone exchange rate regime with a given exchange rate band implies bounds on the amount of depreciation and appreciation of the domestic currency. This implies, for given foreign interest rates, bounds on the domestic-currency rate of return on foreign investment: a...

The term structure of interest rate differentials is derived in a model of a small open economy with a target zone exchange rate regime. The target zone is modeled as a regulated Brownian motion. The interest rate differentials are computed as the solution to a parabolic partial differential...

The credibility of the exchange rate bands in the Nordic countries during 1987-91 is examined with two tests. The results suggest that the credibility of Finland’s exchange rate band within a twelve-month horizon could not be rejected except in the fall of 1991; however, the band lacked...

Existing proposals to escape from a liquidity trap and deflation, including my Foolproof Way,' are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that...

The paper reviews the recent literature on exchange rate target zones and on speculative attacks on fixed exchange rates. The influential Krugman model of exchange rate target zones has two main results, namely that credible target zones stabilize exchange rates more than fundamentals (the...

The foreign exchange risk premium in an exchange rate target zone regime with devaluation/realignment risks is derived. In contrast to previous literature, the exchange rate's heteroscedasticity within the bard, as well as a separate devaluation/realignment risk, is taken into account. The risk...