DP718 Why Have a Target Zone?

Author(s): Paul Krugman, Marcus Miller
Publication Date: October 1992
Keyword(s): Exchange Rates, Speculation, Stabilization, Target Zones
JEL(s): F31, F32
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=718

The desire to avoid speculative runs on currencies appears to be one of the main reasons leading policy-makers to impose currency bands, but the standard analysis of target zones rules out any speculative inefficiencies by assumption. As an alternative we first present simple models of excess volatility due to stop-loss trading and then go on to consider what target zones might accomplish in this context. The principal result is that the speculation of informed traders shifts from being destabilizing to stabilizing, once the target zone assures them that stop-loss orders will not be triggered.