DP1504 The Burden of Intervention: Externalities in Multilateral Exchange Rates Arrangements

Author(s): Marc Flandreau

Publication Date: November 1996

Keyword(s): Central Bank Intervention , Key-currency Regimes , Target Zone

JEL(s): E5 , F31

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP1504.asp

In this paper we consider a regime where several target zones coexist. Parities are defended by manipulating money supplies in participating countries. As a result, interventions aimed at one given exchange rate influence other exchange rates as well. Such ‘externalities’ are shown to have dramatic implications; shocks on each fundamental affect the whole range of exchange rates involved, intra-marginal interventions arise endogenously, and the exchange rate distribution does not exhibit the u-shaped pattern which is typical of traditional target zone models. Moreover, we compute the stationary distribution of exchange rates and fundamentals, and show that both are influenced by the ‘rules of the game’, i.e. currency used in interventions, sterilization procedures, etc.