Informal One-Sided Target Zone Model and the Swiss Franc

35 Pages Posted: 7 Sep 2017

See all articles by Yu-Fu Chen

Yu-Fu Chen

University of Dundee - Department of Economic Studies

Michael Funke

University of Hamburg - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Richhild Moessner

Bank for International Settlements (BIS)

Date Written: August 2017

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.

Keywords: Swiss franc, target zone model, exchange rate interventions

JEL Classification: F31, E42, C61

Suggested Citation

Chen, Yu-Fu and Funke, Michael and Moessner, Richhild, Informal One-Sided Target Zone Model and the Swiss Franc (August 2017). BIS Working Paper No. 660. Available at SSRN: https://ssrn.com/abstract=3030137

Yu-Fu Chen (Contact Author)

University of Dundee - Department of Economic Studies ( email )

Dundee DD1 4HN, Scotland
United Kingdom
+44 1382 344 383 (Phone)
+44 1382 344 691 (Fax)

Michael Funke

University of Hamburg - Department of Economics ( email )

Von-Melle-Park 5
room 2128 C rise
Hamburg, 20146
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Richhild Moessner

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Register to save articles to
your library

Register

Paper statistics

Downloads
12
Abstract Views
152
PlumX Metrics