TY  - JOUR
AU  - Svensson,Lars E.O.
TI  - The Simplest Test of Target Zone Credibility
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 3394
PY  - 1992
Y2  - January 1992
UR  - http://www.nber.org/papers/w3394
L1  - http://www.nber.org/papers/w3394.pdf
N1  - Author contact info:
Lars E.O. Svensson
Sveriges Riksbank
SE-103 37 Stockholm
SWEDEN
Tel: +46 8 787 0107
Fax: +46 8 21 0531
E-Mail: lars.svensson@iies.su.se
AB  - A credible target zone exchange rate regime with a given exchange rate band implies bounds on the amount of depreciation and appreciation of the domestic currency. This implies, for given foreign interest rates, bounds on the domestic-currency rate of return on foreign investment: a rate-of-return band for each time to maturity. Whether domestic interest rates are outside these rate-of-return bands can be used as a simple test of exchange rate credibility, under the assumption of sufficient international capital mobility. This test is applied to the Swedish target zone during February 1986-February 1990.
Under the additional assumption of uncovered interest rate parity, an equivalent test is whether expected future exchange rates are outside the exchange rate band. In addition, the expected future exchange rates are used to give an estimate of the probability of future devaluations.
ER  -