IMF Working Papers

Stabilization Policy with Bands

Author/Editor:

Daniel Gros

Publication Date:

May 1, 1990

Summary:

This paper discusses stabilization policy in the presence of bands for the exchange rate. The bands are modelled in a probabilistic sense: monetary policy has to be such as to keep the probability, that the exchange rate stays within the bands, above a certain threshold. In contrast to other models of target zones, this formulation leads to a linear decision rule and implies sizeable intra-marginal interventions, which corresponds to the experience in the EMS. The extent to which short-run monetary policy is constraint by the bands depends on its own long-run components and on fiscal policy.

Series:

Working Paper No. 1990/049

Subject:

Exchange rates Fiscal policy Foreign exchange Managed exchange rates National accounts Personal income Purchasing power parity