Stochastic intramarginal interventions in target zones |
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| Institution: | 1. Michigan State University, East Lansing, MI 48824, USA;2. Federal Reserve Bank of Cleveland, Cleveland, OH 44126, USA;3. University of Notre Dame, South Bend, IN 46556, USA;1. Center for Pacific Basin Monetary and Economic Studies, Federal Reserve Bank of San Francisco, 101 Market Street, San Francisco, CA 94105, USA;2. Department of Economics, Social Sciences 1, University of California, Santa Cruz, CA 95064, USA;1. Warwick Business School, University of Warwick, Coventry CV4 7AL, UK;2. Department of Economics and Finance, University of Durham, 23–26 Old Elvet, Durham DH1 3HY, UK;1. Department of Economics, University of Wales, Swansea SA2 8PP, UK;2. Department of Economics, University of St Andrews, Fife KY16 9AL, UK |
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| Abstract: | In this paper, we develop an exchange rate target zone model with stochastic intramarginal interventions that generalizes Krugman's standard model. We assume that money supply changes are (negative) proportional to the velocity shocks. The model produces realistic patterns for the relationship among exchange rate, fundamentals and interest rate differentials, which can explain some empirical failures of previous target zone models. The main result derived from the model is that non-linearities in the behavior of both exchange rate and interest rate differential disappear as intramarginal interventions increase. |
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