Soft Exchange Rate Bands and Speculative Attacks: Theory, and Evidence from the ERM since August 1993

Author/Editor:

Leonardo Bartolini ; Alessandro Prati

Publication Date:

November 1, 1998

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

We present a model of a “soft” exchange rate target zone and interpret it as a stylized description of the post-August 1993 ERM. Our central bank targets a moving average of the current and past exchange rates, rather than the exchange rate’s current level, thus allowing the rate to move within wide margins in the short run, but within narrow margins in the long run. For realistic parameters, soft target zones are significantly less vulnerable to speculative attacks than “hard” target zones. These predictions are consistent with the ERM’s experience and the abatement of speculative pressure in European markets since the bands’ widening in 1993.

Series:

Working Paper No. 1998/156

Subject:

Banking Crawling peg Currency markets Exchange rate adjustments Exchange rates Financial markets Foreign exchange Managed exchange rates

English

Publication Date:

November 1, 1998

ISBN/ISSN:

9781451857375/1018-5941

Stock No:

WPIEA1561998

Pages:

29

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