Target Zones and Exchange Rate Dynamics

Paul R. Krugman

NBER Working Paper No. 2481
Issued in 1988
NBER Program(s):   ITI   IFM

This paper develops a highly simplified model of exchange rate behavior within the band under a target zone regime. It shows that the expectation that authorities will defend the band exerts a stabilizing effect on exchange rate behavior within the band, even when the authorities are not actively intervening. The extent of stabilization can be related in a straightforward way to three factors: the sensitivity of the current exchange rate to expected depreciation, the volatility of the process driving exchange rate "fundamentals", and the credibility of the commitment by authorities to defend the target zone.

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Document Object Identifier (DOI): 10.3386/w2481

Published: Quarterly Journal of Economics, Vol. 106, no. 3 (1991): 669-682. citation courtesy of