Informal One-Sided Target Zone Model and the Swiss Franc

Yu-Fu Chen, Michael Funke, Richhild Moessner

    Research output: Contribution to journalArticle

    Abstract

    This paper develops a new theoretical model with an asymmetric informal one-sided exchange rate target zone, with an application to the Swiss franc following the removal of the minimum exchange rate of CHF 1.20 per euro in January 2015. We extend and generalize a standard target zone model by introducing perceived uncertainty about the lower edge of the band. We find that informal soft edge target zone bands lead to weaker honeymoon effects, wider target zone ranges, and higher exchange rate volatility than formal target zone bands. These results suggest that it would be beneficial for exchange rate policy intentions to be stated clearly in order to anchor exchange rate expectations and reduce exchange rate volatility. We also study how exchange rate dynamics can be characterized in models in which financial markets are aware of occasional changes in the policy regime. We show that expected changes in the central bank's exchange rate policy may lead to exchange rate oscillations, providing an additional source of exchange rate volatility, and to capture this it is important to take into account the possibility of regime changes in exchange rate policy.

    Original languageEnglish
    Pages (from-to)1130-1153
    Number of pages24
    JournalReview of International Economics
    Volume26
    Issue number5
    Early online date26 Jul 2018
    DOIs
    Publication statusPublished - Nov 2018

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    Keywords

    • Swiss franc
    • target zone model
    • exchange rate interventions

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