Journal Article

Exchange Rate Dynamics in a Multilateral Target Zone

Angel Serrat

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 67, issue 1, pages 193-211
Published in print January 2000 | ISSN: 0034-6527
Published online January 2000 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/1467-937X.00127
Exchange Rate Dynamics in a Multilateral Target Zone

More Like This

Show all results sharing this subject:

  • Economics

GO

Show Summary Details

Preview

This paper presents a model of exchange rate behaviour in a multilateral target zone. The model produces new economic insights beyond the well-known bilateral model of Krugman (1991), which is obtained as a special case. The paper also introduces a new class of stochastic processes in economics, namely multidimensional reflected diffusion processes.

Two main features characterize the economics of exchange rates in a multilateral target zone. (i) The restrictions on interventions imposed by cross-currency constraints: when one country changes its money supply, say because its exchange rate with a second country has hit its band, all exchange rates involving the currency of that particular country will be affected, regardless of their position within their respective bands, (ii) Cooperation in sharing the intervention burden: in general, the exchange rate between any two countries will depend on the fundamentals of third countries in a multilateral target zone. This is because if the monetary authorities intervene together, a shock in the fundamentals of any country will induce a revision of the expectation of future interventions of other countries.

The model reverts the counterfactual predictions of the bilateral model that the exchange rate steady-state density should be U-shaped and that its volatility should be a decreasing function of the distance of the exchange rate to the limits of its band. Thus, accounting for the multilateral feature of real-world target zones allows us to reconcile target zone models with the most salient empirical features of exchange rate behaviour.

Journal Article.  0 words. 

Subjects: Economics

Full text: subscription required

How to subscribe Recommend to my Librarian

Users without a subscription are not able to see the full content. Please, subscribe or login to access all content.