How to Run a Target Zone? Age-Old Lessons from an Austro-Hungarian Experiment

41 Pages Posted: 19 Sep 2001

See all articles by Marc Flandreau

Marc Flandreau

Fondation Nationale des Sciences Politiques - Institut d'Etudes Politiques de Paris; Centre for Economic Policy Research (CEPR)

John Komlos

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: September 2001

Abstract

This paper considers what we argue was the first experiment of an exchange rate band. This experiment took place in Austria-Hungary between 1896 and 1914. The rationale for introducing this policy rested on precisely those intuitions that modern target zone literature has recently emphasized: the band was designed to secure both exchange rate stability and monetary policy autonomy. However, unlike more recent experiences, such as the ERM, this policy was not undermined by credibility problems. In other words the episode provides us with an ideal testing ground for some important ideas in modern macroeconomics: specifically, can formal rules, when faithfully adhered to, provide policy makers with some advantages such as short term flexibility? First, we find that a credible band has a "microeconomic" influence on exchange rate stability. By reducing uncertainty, a credible fluctuation band improves the quality of expectations, a channel that has been neglected in the modern literature. Second, we show that the standard test of the basic target zone model is flawed and develop an alternative methodology. This enables us to understand why Austro-Hungarian policy makers were so upbeat about the merits of exchange rate target zones. We believe that these findings shed a new light on the economics of exchange rate bands.

JEL Classification: F31, N32

Suggested Citation

Flandreau, Marc and Komlos, John, How to Run a Target Zone? Age-Old Lessons from an Austro-Hungarian Experiment (September 2001). CESifo Working Paper Series No. 556. Available at SSRN: https://ssrn.com/abstract=283731

Marc Flandreau

Fondation Nationale des Sciences Politiques - Institut d'Etudes Politiques de Paris ( email )

27 rue Saint-Guillaume
Paris Cedex 07, 75337
France
+33 1 4046 7265 (Phone)
+33 1 4407 0750 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

John Komlos (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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