The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

Markus Hertrich

MPRA Paper from University Library of Munich, Germany

Abstract: In the aftermath of the recent financial crisis, the central banks of small open economies such as the Czech National Bank and the Swiss National Bank (SNB) both implemented a unilateral one-sided exchange rate target zone vis-a-vis the euro currency to counteract deflationary pressures. Recently, the SNB abandoned its minimum exchange rate regime of CHF 1.20 per euro, arguing that after having analyzed the costs and benefits of this non-standard exchange rate policy measure, it was no longer sustainable. This paper proposes a model that allows central banks to estimate ex-ante the costs of implementing and maintaining a unilateral one-sided target zone and to monitor these costs during the period where it is enforced. The model also offers central banks a tool to identify the right timing for the discontinuation of a minimum exchange rate regime. An empirical application to the Swiss case shows the actual size of these costs and reveals that these costs would have been substantial without the abandonment of the minimum exchange rate regime, which accords with the official statements of the SNB.

Keywords: Foreign exchange reserves; minimum exchange rate; reflected geometric Brownian motion; target zone costs; Swiss National Bank (search for similar items in EconPapers)
JEL-codes: E42 E52 E58 E6 E63 F33 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
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Related works:
Journal Article: The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:67839

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