Working Paper: CEPR ID: DP845
Authors: Patrick Honohan
Abstract: 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 exchange rate data for the EMS do not display this feature, but in contrast cluster towards the middle of the band. We show that such findings result from neglect of the multi-currency nature of the EMS and are overturned when account is taken of the full set of intervention obligations.
Keywords: exchange rates; target zones; european monetary system
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| multilateral intervention obligations (F53) | distribution of exchange rates (F31) |
| bilateral methodology (C90) | misleading findings regarding exchange rates (F31) |
| multilateral obligations considered (F53) | distribution of exchange rates close to uniform (F31) |
| previous studies (bilateral) (Y80) | U-shaped distribution prediction (C46) |
| correction for multilateral obligations (F53) | weakens case against credible target zone hypothesis (F31) |