We examine the effects of endogenously determined realignment expectations in a model of a target zone with sluggish price adjustment. We allow these expectations to be based on a policy rule which attaches differing weights to output and price stability. We find that for realistic parameter...

In credible target zone regimes, exchange rates should, according to Krugman's 1991 theory, spend a disproportionate amount of time near the edges of the fluctuation band. The major application of this theory has been to the European Monetary System (EMS), with several authors reporting that...

This paper provides a theoretical evaluation of two of the most influential recent proposals for international monetary reform, namely McKinnon's standard with fixed exchange rates and Williamson's target zones. The focus is on the implications of the proposals for short-run stabilization...

Exchange rate target zone models postulate that `in the absence of intervention' exchange rates are driven by their fundamentals, which in this case are assumed to follow an unregulated Brownian motion process-the continuous time equivalent of a random walk (with drift). Such random walk...

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 modelled as a regulated Brownian motion. The interest rate differentials are computed as the solution to a parabolic partial differential...

We formulate a stochastic, rational-expectations model of exchange rate determination, in which there are random shocks to the process of sluggish price adjustment. We examine the effects of imposing limits upon the range of variation of both nominal and real exchange rates and describe the...

The trade-off between interest rate variability and the width of an exchange rate target zone is examined, using the regulated Brownian motion model of target zones. It is shown that for narrow exchange rate bands, and for reasonable parameter values, the interest rate differential's asymptotic...

This paper distinguishes between some obvious necessary and sufficient conditions for adopting the target zone proposal as a means of improving macroeconomic performance. The necessary conditions may be satisfied fairly easily, but it is a good deal more difficult to design a targeting system...

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 band, as well as a separate devaluation/realignment risk, is taken into account. The risk...

Recently developed models of exchange rate dynamics emphasize the expectational effects of infrequent intervention. This paper proposes a stylized probabilistic framework in which such effects can be studied along with realistic concerns about the sustainability of the intervention policy. In...