DP698 Target Zone Models with Price Inertia: Some Testable Implications
| Author(s): | Alan Sutherland |
| Publication Date: | August 1992 |
| Keyword(s): | Exchange Rates, Price Inertia, Target Zones |
| JEL(s): | F31, F33 |
| Programme Areas: | International Macroeconomics |
| Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=698 |
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.