Target Zones with Limited Reserves

Paul Krugman and Julio Rotemberg

No 3418, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Like a fixed exchange rate, a target zone system may be subject to speculative attacks when the reserves of the central bank are limited. This paper analyzes such speculative attacks and their implications; it shows that the recently developed "smooth pasting" model of target zones should be viewed as a special case that emerges only when reserves are sufficiently large. The paper then uses the target zone framework to resolve a seeming paradox in predicting speculative attacks on a gold standard, arguing that such a standard may best be viewed as the boundary between one-sided target zones.

Date: 1990-08
Note: ITI IFM
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