Estimating credibility in Colombia's exchange rate target zone

The paper aims to highlight the main difficulties on the monetary path towards the euro zone experienced by Emerging Europe. Emerging European Economies (EEEs), EU members, adopted either double shift or smooth transition monetary approach towards the euro zone. Double shift assumes changes from floating exchange rate regimes (ERRs) to the ERM II target zone and, finally, monetary union as a rigid ERR. The smooth transition is practiced by economies with mainly rigid ERRs before the ERM II entrance and, at the end, again rigid ERR of a monetary union. Despite chosen monetary path towards the euro zone, crucial difficulties or aggravating factors could be identified in the form of real exchange rate appreciation due to productivity growth or capital inflows. A reconciliation of inflation and exchange rate target zone is extremely complex, at the same time striving not to jeopardize the real convergence. What is stressed here is the vicious cycle between real and nominal convergence as the reason why the ERM II target should be regarded as a “waiting room“ not as a “training room“ in the pre-EMU phase.

Exchange Rate Dynamics in a Target Zone - A Heterogeneous Expectations Approach

Perfect and Imperfect Credibility: A Brazilian Target Zone Analysis

This article presents a new way of modeling the dynamics of an exchange rate target zone. In the presence of a single upper (lower) target boundary, the exchange rate is precisely represented as the sum of a free float and a short (long) position in a call (put) option with strike price at the boundary. To model a target zone (with two boundaries), a natural approach consists of describing the exchange rate dynamics as the combination of the two, namely the sum of free float together with a long position in a put written on the lower boundary and a short position in a call option written on the upper boundary, respectively. The authors show that this first order approximation leads to significant mispricing (as much as 20%) and must be iterated, leading to an infinite sequence of compounded “mirrored” option prices. They analyze basic properties of such mirrored nested options analytically, describe how to calculate them numerically, and show why it is crucial to take into account higher order corrections in realistic target zones. They argue that this analogy to option prices allows for conceptually simple generalizations that describe different target zone arrangements. They then apply their methodology to the estimation of the fundamental value of the Hong Kong dollar that is hidden by the target zone pegged to the US dollar. They also estimate the implied maturity and explain how this parameter serves as direct proxy for target zone credibility.

An arbitrage free trilateral target zone model

Exchange rate fluctuations, plant turnover and productivity

On the mean-reverting properties of target zone exchange rates: Some evidence from the ERM

An analytical approximation of target zone exchange rate functions: the technique of collocation

An algorithmic approach to exchange rate stabilization

I examine authorities' interventions in goods and money markets to keep exchange rates within targeted zones, in an economy where both the exchange rate and the prices of goods are interdependent forward-looking variables. I show that, (1) in order to support target zones in both goods and money markets, there needs to be coordinated, simultaneous intervention in the two markets; (2) intervention takes place almost certainly before the exchange rate or the price level reaches its upper or lower bounds; and (3) zones for the exchange rate and for the price level cannot be separately designed as independent policy goals.

In this paper, the following question is posed: Can the New Keynesian Open Economy Model by Galí and Monacelli (2005b) explain “Six Major Puzzles in International Macroeconomics”, as documented in Obstfeld and Rogoff (2000b)? The model features a small open economy with complete markets, Calvo sticky prices and monopolistic competition. As extensions, I explore the effects of an estimated Taylor rule and additional trade costs. After translating the six puzzles into moment conditions for the model, I estimate the five most effective parameters using simulated method of moments (SMM) to fit the moment conditions implied by the data. Given the simplicity of the model, its fit is surprisingly good: among other things, the home bias puzzles can easily be replicated, the exchange rate volatility is formidably increased and the exchange rate correlation pattern is relatively close to realistic values. Trade costs are one important ingredient for this finding.

Estimating Nonlinear DSGE Models by the Simulated Method of Moments

Quantitative Modelling of the EUR/CHF Exchange Rate During the Target Zone Regime of September 2011 to January 2015: A Correction

Part 1 International policy co-ordination and exchange rate management: the European monetary system, exchange rate expectations and the reputation of authorities, P.Artus would US protectionism be a threat to economic stability?, A.J.Hughes Hallett and G.J.Huston international adjustment and the dollar - a game theoretic approach, J.C.Martinez Oliva exchange rates and policy co-ordination in an asymmetric model, P.Kennen international policy co-ordination, imperfect information and target zones, A.Bisin and P.Tedeschi target zones, currency options and the dollar, P.Weller. Part 2 Strategic aspects of international policy co-ordination: time inconsistency, discounting and the returns to co-operation, M.Miller, et al policy co-operation among benevolent governments may be undesirable - an extension, P.J.Kehoe can international policy co-ordination really be counterproductive?, C.Carraro and F.Giavazzi profit shifting motives and international trade union co-ordination, D.Laussel and A.Soubeyran. Part 3 Information and uncertainty: robust lyapunov games under bounded uncertainty, C.Diessenberg asymmetric information and policy co-ordination, M.Cripps international policy co-ordination in a world with model uncertainty, A.R.Ghosh and P.R.Masson.

The first known experiment with an exchange rate band took place in Austria- Hungary between 1896 and 1914. The rationale for introducing this policy rested on precisely those intuitions that the modern literature has emphasized: the band was designed to secure both exchange rate stability and monetary policy autonomy. However, unlike more recent experiences, such as the ERM, this policy was not undermined by credibility problems. The episode provides an ideal testing ground for some important ideas in modern macroeconomics: specifically, can formal rules, when faithfully adhered to, provide policy makers with some advantages such as short term autonomy? First, we find that a credible band has a "microeconomic" influence on exchange rate stability. By reducing uncertainty, a credible fluctuation band improves the quality of expectations, a channel that has been neglected in the modern literature. Second, we show that the standard test of the basic target zone model is flawed and develop an alternative methodology. We believe that these findings shed a new light on the economics of exchange rate bands.