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324 CHAPTER 10. TARGET-ZONE MODELSλ 1 = −λ 2 = λ = q 2/(ασ 2 ) > 0, and ˜B = −Ã >0.(218)⇒To determine ˜B, suppose that f hits the upper band ¯f at time t 0 .Thens(t 0 )=G( ¯f|f, ¯f) = ¯f + ˜B(e −λβ − 1). (10.51)At the next instant t 0 + dt, the authorities either realign or defends(t 0 + dt) =(G( ¯f + β/2| ¯f, ¯f + β) = ¯f +β2w.p. pG( ¯f − β/2|f, ¯f) = ¯f − β 2w.p. 1 − p.(10.52)To maintain uncovered interest parity at the point of intervention, marketparticipants must not expect jumps in the exchange rate. It followsthat, lim ∆t→0 E t0 s(t 0 +∆t) =s t0 . Using (10.52) to evaluate E t0 s(t 0 +dt)and equating to s(t 0 )givesp"¯f + β 2#+(1− p)"¯f − β 2#= ¯f + ˜B(e −λβ − 1),and solving for ˜B gives˜B = (2p − 1) β 2). (10.53)(e −λβ − 1This solution is a striking contrast to the solution under Krugmaninterventions. ˜B is negative if the target zone lacks sufficient credibility(p > 1 ). This means that the exchange rate solution is an inverted ‘Scurve’.The exchange rate under the discrete intervention rule combined2with low defense credibility is even more volatile than what it would beunder a free ßoat.
10.6. IMPERFECT TARGET-ZONE CREDIBILITY 325Target-zone Summary1. The theory covered in this chapter was based on the monetarymodel where today’s exchange rate depends in part on marketparticipant’s expectations of the future exchange rate. Under atarget zone, these expectations depend on the position of the exchangerate within the zone. As the exchange rate moves fartheraway from the central parity, intervention that manipulates theexchange rate becomes increasingly likely and the expectationof this intervention feeds back into the current value of s(t).2. When the fundamentals follows a diffusion process forf
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To Shirley, Laurie, and Leslii
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CONTENTSvii11 Balance of Payments C
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2 CHAPTER 1. SOME INSTITUTIONAL BAC
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80 CHAPTER 3. THE MONETARY MODEL3.1
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106 CHAPTER 4. THE LUCAS MODEL(76)
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108 CHAPTER 4. THE LUCAS MODELsubje
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124 CHAPTER 4. THE LUCAS MODELTable
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126 CHAPTER 4. THE LUCAS MODEL4.5 C
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128 CHAPTER 4. THE LUCAS MODELTable
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132 CHAPTER 4. THE LUCAS MODEL1.02A
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134 CHAPTER 4. THE LUCAS MODELAppen
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136 CHAPTER 4. THE LUCAS MODELProbl
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138 CHAPTER 5. INTERNATIONAL REAL B
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162CHAPTER 6. FOREIGN EXCHANGE MARK
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208 CHAPTER 7. THE REAL EXCHANGE RA
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230 CHAPTER 8. THE MUNDELL-FLEMING
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264CHAPTER 9. THE NEW INTERNATIONAL
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Page 282 and 283: 274CHAPTER 9. THE NEW INTERNATIONAL
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Page 368 and 369: Subject IndexAAbsorption, 16, 230AI
Page 370 and 371: 362 SUBJECT INDEXEfficient capital
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Page 374 and 375: 366 SUBJECT INDEXRisk neutrality, 9
Page 376: 368 SUBJECT INDEXImpulse response a
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