Working Paper: CEPR ID: DP1504
Authors: Marc Flandreau
Abstract: In this paper we consider a regime where several target zones coexist. Parities are defended by manipulating money supplies in participating countries. As a result, interventions aimed at one given exchange rate influence other exchange rates as well. Such ?externalities? are shown to have dramatic implications; shocks on each fundamental affect the whole range of exchange rates involved, intra-marginal interventions arise endogenously, and the exchange rate distribution does not exhibit the u-shaped pattern which is typical of traditional target zone models. Moreover, we compute the stationary distribution of exchange rates and fundamentals, and show that both are influenced by the ?rules of the game?, i.e. currency used in interventions, sterilization procedures, etc.
Keywords: target zone; central bank intervention; key-currency regimes
JEL Codes: E5; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interventions to stabilize a specific exchange rate (F31) | Intramarginal interventions arise endogenously (F12) |
| Interventions by one central bank (E58) | Influence the exchange rates of others (F31) |
| Intervention by one central bank to support its currency (F31) | Destabilize another currency's exchange rate (F31) |
| Presence of externalities (D62) | Modifies the traditional honeymoon effect (D15) |
| Modified traditional honeymoon effect (C41) | Reduced sensitivity of exchange rates to movements in relative money supplies (E49) |
| Modified traditional honeymoon effect (C41) | Increased sensitivity to movements of other countries' money supplies (F41) |
| Dynamics of exchange rate behavior are fundamentally altered in a multilateral context (F31) | Traditional target zone model does not adequately capture complexities (F12) |