Dynamic Inconsistency and Exchange-Rate Target Zones: A Welfare Analysis

Zhen Zhu

International Economic Journal, 1997, vol. 11, issue 1, 15-38

Abstract: This paper examines the welfare implications of different exchange-rate systems, especially an exchange-rate target-zone system, in a context of monetary policy making and dynamic inconsistency. It is shown that when there is uncertainty, there is a trade-off between commitment to a rule and discretion. A free-floating exchange-rate system may have the same loss function values in terms of price and output fluctuations as that of a target zone. However, a target-zone system may be more attractive since there is less exchange-rate fluctuation. Returning to a fixed-rate system may be worse since it may bring about larger welfare losses especially when supply shocks dominate. [F31, E52]

Date: 1997
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DOI: 10.1080/10168739700000002

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