DP3337 Exchange Rate Monitoring Bands: Theory and Policy

Author(s): Luisa Corrado, Marcus Miller, Lei Zhang
Publication Date: April 2002
Keyword(s): monitoring band, near random walk dynamics, non-linear mean-reversion
JEL(s): D52, F31, G12
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3337

Recent empirical research by Mark Taylor and co-authors has found evidence of hybrid dynamics for real exchange rates. While there is a random walk near equilibrium, for real exchange rates some distance from equilibrium there is mean-reversion which increases with the degree of misalignment. An interesting question is whether this non-linear mean-reversion might be policy-induced. John Williamson (1998), for example, has proposed a ?monitoring band? in which there is no intervention near equilibrium but there is substantial intervention triggered by exchange rate deviations outside a preset band. In this Paper we develop a theoretical model of such a monitoring band to see whether it can generate patterns of non-linear mean-reversion akin to those reported in empirical research.