Endogenous realignments in a target zone

Christopher Neely, Paul A. Weller and P. Dean Corbae

Oxford Economic Papers, 2003, vol. 55, issue 3, 494-511

Abstract: We examine the effects of endogenously determined realignment expectations in a model of a target zone with sluggish price adjustment. We allow these expectations to be based on a policy rule which generates an increasing probability of realignment as output moves away from full employment. For realistic parameter values, relatively small misalignments of the currency band lead to strongly skewed conditional distributions for the nominal exchange rate, thus generating pressures for realignment. The reason for this is that the speed of adjustment in the absence of realignments is rather slow. Even infrequent realignments significantly increase the speed of adjustment. Copyright 2003, Oxford University Press.

Date: 2003
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