Working Paper: CEPR ID: DP742
Authors: Lars E. O. Svensson
Abstract: The paper argues that real world fixed exchange rate regimes usually have finite bands instead of completely fixed exchange rates between realignments because exchange rate bands, contrary to the textbook result, give central banks some monetary independence even with free international capital mobility. The nature and amount of monetary independence is specified, informally and in a formal model, and quantified with Swedish krona data. The amount of monetary independence thus achieved appears sizeable. For instance, an increase in the Swedish krona band from zero to about +2% may reduce the krona interest rate's standard deviation by about 1/2.
Keywords: Target zones; Interest rates; Monetary policy; Mean reversion
JEL Codes: F31; F33; F41; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate bands (F33) | monetary independence (E49) |
| exchange rate bands (F33) | domestic interest rates (E43) |
| expectations of currency depreciation (F31) | domestic interest rates (E43) |
| increase in krona's band (F31) | standard deviation of krona interest rates (E43) |
| monetary independence (E49) | domestic interest rates (E43) |