Exchange Rate Economics: Theories and Evidence

300 Target zone models
% expected depreciation over next 3 months
1.5
(a)
1
0.5
0
–0.5
–1
–1.5
–2
–2.5
–3
57.04
59.04 61.04 63.04 65.04 67.04 69.04 71.04
Year and month
% expected depreciation over next 3 months
4
3
2
1
0
–1
(b)
–2
57.04 59.04 61.04 63.04 65.04 67.04 69.04 71.04
Year and month
Figure 12.6 Ninety-five confidence intervals for expected depreciation in Bretton Woods:
(a) of deutsche mark (b) of sterling.
Source: Giovannini (1993).
intervention policies of European central banks for the ERM period and find that
practically all of the intervention occurs within the band; that is,the intervention is
intra-marginal. These findings are reinforced by Giavazzi and Giovannini (1989)
and Lindberg and Soderlind (1991).
In sum,then,the model assumptions are not well supported on data for the ERM
period,the episode for which the target zone model was originally formulated.
However,there is more support for the model especially when other fixed rate
regimes are considered,such as the two gold standard episodes.
12.1.4 Target zone model predictions
A key prediction of the model is that x t and E t s t+k should be negatively related;
that is,if x t is above the central parity this will generate an expectation of an