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Title: Target Zone Models with Price Inertia: Some Testable Implications

Author(s): Alan Sutherland

Publication Date: August 1992

Keyword(s): Exchange Rates, Price Inertia and Target Zones

Programme Area(s): International Macroeconomics

Abstract: Many recent papers suggest that the basic flex-price target zone model does not perform well empirically. This paper derives some of the testable implications of a sticky-price target zone model in order to determine whether the assumption of perfect price flexibility explains the empirical failure of the basic model. I find that while price inertia does introduce mean reversion into the exchange rate, the behaviour of nominal variables is otherwise not qualitatively different from the flex-price model. The paper therefore concludes that the flex-price assumption is not an adequate explanation for empirical failure of the target zone basic model.

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Bibliographic Reference

Sutherland, A. 1992. 'Target Zone Models with Price Inertia: Some Testable Implications'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=698