NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates

Lars E.O. Svensson

NBER Working Paper No. 4207 (Also Reprint No. r1893)
Issued in June 1994
NBER Program(s):   IFM

The paper argues that the reason real world fixed exchange rate regimes usually have finite bands instead of completely fixed exchange rates between realignments is that exchange rate bands, counter to the textbook result, give central banks some monetary independence, even with free international capital mobility. The nature and amount of monetary independence is specified, informally, and in a formal model, and quantified with Swedish krona data. Altogether the amount of monetary independence appears sizable. For instance, an increase in the Swedish krona band from zero to about plus or minus two percent may reduce the krona interest rate's standard deviation by about one-half.

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Published: Journal of Monetary Economics, vol. 33, 1994, pp. 157-199

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