DP845 The European Monetary System and the Theory of Target Zones

Author(s): Patrick Honohan
Publication Date: September 1993
Keyword(s): European Monetary System, Exchange Rates, Target Zones
JEL(s): F31, F33
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=845

In credible target zone regimes, exchange rates should, according to Krugman's 1991 theory, spend a disproportionate amount of time near the edges of the fluctuation band. The major application of this theory has been to the European Monetary System (EMS), with several authors reporting that exchange rate data for the EMS do not display this feature, but in contrast cluster towards the middle of the band. We show that such findings result from neglect of the multi-currency nature of the EMS and are overturned when account is taken of the full set of intervention obligations.