Abstract:

From the traditional gold standard up to the current EU's ERM2 arrangement, the target zone regime has already become an influential exchange rate regime.This paper presents a benchmark model that is based on the Krugman standard theory, and rationalizes the choice of target zone instead of other regimes owing to its fixed rate, and free and managed float.The target zone may be a cause of stabilizing or destabilizing exchange rate expectations, which crucially depends on the within-band central bank policy as well as the credibility of commitment to defend the target zone.

Key words: exchange rate regime, target zone regime, Krugman model, RMB