DP221 Evaluating the Extended Target Zones Proposal for the G3

Author(s): David Currie, Simon Wren-Lewis
Publication Date: January 1988
Keyword(s): Exchange Rates Targets, Feedback Rules, Fiscal Policy, Interest Rates, Policy Coordination
JEL(s): 133, 321, 431
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=221

This paper evaluates the extended target zone proposal of Williamson and Miller using the National Institute world economic model (GEM). Williamson and Miller's proposals envisage that real exchange rates will be controlled by movements in relative interest rates, that fiscal policy will be used to steer nominal demand towards a target which depends on capacity utilization, inflation and the current balance, and that the average level of world interest rates will be used to control global nominal demand. We evaluate the performance of these rules for the United States, Germany and Japan over the period 1975-84, using control methods to determine the best choice of parameters in the feedback rules. We then consider how history would have differed from actual events had such rules been in place. The results suggest that such rules would have led to a significant improvement in economic performance: exchange rate variability would have been reduced and the dramatic increase in United States interest rates which took place after 1980 would have been avoided.