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Informal one-sided target zone model and the Swiss franc

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  • Yu-Fu Chen
  • Michael Funke
  • Richhild Moessner

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 the standard target zone model of Krugman (1991) 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.

Suggested Citation

  • Yu-Fu Chen & Michael Funke & Richhild Moessner, 2017. "Informal one-sided target zone model and the Swiss franc," BIS Working Papers 660, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:660
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    Cited by:

    1. Park, Ki Young & Kim, Soohyon, 2019. "Detecting currency manipulation: An application of a state-space model with Markov switching," Japan and the World Economy, Elsevier, vol. 49(C), pages 50-60.
    2. Lu, You-Xun, 2022. "The stabilizing effect of the zero lower bound: A perspective of interest rate target zones," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 61-67.
    3. Hertrich, Markus, 2020. "Foreign exchange interventions under a one-sided target zone regime and the Swiss franc," Discussion Papers 21/2020, Deutsche Bundesbank.

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    More about this item

    Keywords

    Swiss franc; target zone model; exchange rate interventions;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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