Exchange Rate Bands

Exchange Rate Bands

The range of exchange rates a central bank allows its currency to take. Exchange rate bands are used when one currency links its value to that of another currency but allows it to fluctuate within certain limits. Proponents maintain that exchange rate bands give a currency a certain level of flexibility so that it can respond to market factors while leaving control with the central bank. Critics contend that this system is inefficient and leads to unfair practices in international trade. The Chinese renmimbi is a prominent example of a currency that traditionally has existed within exchange rate bands. See also: Crawling peg.
References in periodicals archive ?
"Why Exchange Rate Bands? Monetary Independence In Spite of Fixed Exchange Rates." Journal of Monetary Economics, 33, 1994, 157-99.
(1) Following Krugman (1991), an exchange rate bands regime is credible when the market agents believe that the lower and upper edges of the band will remain fixed and no changes in central parity are expected.
Helpman, Elhanan, Leonardo Leiderman and Gil Bufman (1994), "A New Breed of Exchange Rate Bands", Economic Policy: A European Forum, vol.
Starting in November 1991, when inflation was running at 20% in annual terms, Mexico adopted a system of gradually widening exchange rate bands aimed at giving the central bank scope to strike a better balance between the "credibility" and "flexibility" of its monetary regime (Helpman et al., 1994).
To allow greater policy flexibility, the Mexican central bank began to use exchange rate bands instead of a fixed exchange rate in late 1991.
The Central Bank raises its interest rates by 30 basis points to 10.1 per cent and announces that it has widened the exchange rate bands from 6 per cent to 9 per cent.
The most plausible solution to this problem seems to be crawling exchange rate bands. As a dynamic version of exchange rate pegging, these had become popular during the 1980s and 1990s in moderate-inflation middle-income countries such as Chile, Colombia, Israel, and Mexico, as well as in some transition countries such as Hungary, Poland, and Russia.
Dominguez and Kenen [1992] present ample evidence, however, that central banks mainly defend exchange rate bands by intramarginal "leaning-against-the-wind" interventions, so as to keep the exchange rate well away from the edges.
'Why Exchange Rate Bands? Monetary Independence in Spite of Fixed Exchange Rates', Journal of Monetary Economics, 33, 157-99.
Practical inflation targeting has several common characteristics: 1) an announced quantitative inflation target, varying across countries between 1.5 and 2.5 percent per year, in most countries with a tolerance band of plus/minus 1 percentage point around the target; 2) no explicit rule on how the central bank shall set its instrument; 3) a floating exchange rate (except for Finland and Spain, which are members of the Exchange Rate Mechanism, although the wide exchange rate bands there so far have not created any conflict between the inflation target and the exchange rate target); and 4) a high degree of transparency and accountability.
(1994), `A New Breed of Exchange Rate Bands: Chile, Israel and Mexico', Economic Policy.
The short-term response to the widening of the exchange rate bands was both interesting and instructive.