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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 13, No. 1, pp.49-68
ISSN: 1225-0279 (Print)
Print publication date 29 Feb 2000
Received Feb 1999 Revised Mar 2000

Optimal Target Zone and Stability Tradeoff

Chan-Woo Jeong
Assistant Professor, Department of Business Administration, Chonnam National University, Kwangju 500-757, Korea, Tel: +82-62-530-1456 jeongcw@chonnam.ac.kr

JEL Classification: F31, F33, F41

Abstract

Conventional literature on exchange rates largely ignores normative issues of the target zone regime. This paper builds a model for the optimal target zone and considers whether the target zone is desired compared to other exchange rate regimes. The paper finds that when the central bank's objective is to minimize the sum of price and output variances, a target zone regime is superior to a fixed or floating exchange rate. In determining the band width, a tradeoff exists between output and price stability, with a wider band producing smaller output variability and larger price variability.

Acknowledgments

I am thankful to Sheng Hu, Jerry Thursby, John Barron and especially John Carlson for helpful comments and suggestions. Comments from the seminar participants in the Midwest International Economics Conference at Penn State are also appreciated. Also financial support from the Research Fund of Chonnam National University is gratefully acknowledged. However, I am alone responsible for all remaining errors.

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