DP3337 Exchange Rate Monitoring Bands: Theory and Policy

Author(s): Luisa Corrado , Marcus Miller , Lei Zhang

Publication Date: April 2002

Keyword(s): monitoring band , non-linear mean-reversion , near random walk dynamics

JEL(s): D52 , F31 , G12

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP3337.asp

Recent empirical research by Mark Taylor and co-authors has found evidence of hybrid dynamics for real exchange rates. While there is a random walk near equilibrium, for real exchange rates some distance from equilibrium there is mean-reversion which increases with the degree of misalignment. An interesting question is whether this non-linear mean-reversion might be policy-induced. John Williamson (1998), for example, has proposed a ‘monitoring band’ in which there is no intervention near equilibrium but there is substantial intervention triggered by exchange rate deviations outside a preset band. In this Paper we develop a theoretical model of such a monitoring band to see whether it can generate patterns of non-linear mean-reversion akin to those reported in empirical research.