Implicit Band within the Announced Exchange Rate Band

Miklós Koren ()
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Miklós Koren: Harvard University, Dept. of Econ.

No 5, Rajk László Szakkollégium Working Papers from Rajk László College

Abstract: The paper provides an explanation to the policy of implicit exchange rate bands. Especially when introducing a new exchange rate band or modifying the old one, central banks often intervene intra-marginally, targeting a narrower band than that announced. The theoretical literature provides little clue to understand this phenomenon. The models either do not differ-entiate between the mechanism of announced (known) and implicit (unknown) exchange rate bands, or fail to account for the central bank's incentives in exchange rate policy. I present a model, which both distinguishes the announced from the true target zone and endogenizes the choice of the bandwidth. I argue that implicit bands are a mean to signal the objectives of exchange rate policy. Announcement of the bandwidth cannot credibly do this, since it is not binding for the central bank. That is, the announcement is only partially believed. On the other hand, the choice of the actual bandwidth may serve as a costly signal. Since stability-concerned central banks are more likely to accept the costs of intervening intra-marginally, narrow implicit bands may effectively communicate the preferences for exchange rate stabil-ity. I conclude that a low level of reputation and a high concern of exchange rate stability both make the policy of implicit band more likely.

Keywords: Exchange Rate; Exchange Rate Regime; Target Zone; Credibility; Signaling (search for similar items in EconPapers)
JEL-codes: C73 E58 F31 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2000-11
New Economics Papers: this item is included in nep-ifn
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