Target Zones in History and Theory: Lessons from an Austro-Hungarian Experiment (1896-1914)

University of Munich Economics Discussion Paper No. 2003-18

37 Pages Posted: 22 Nov 2003

See all articles by John Komlos

John Komlos

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

Marc Flandreau

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

Abstract

The first known experiment with an exchange rate band took place in Austria-Hungary between 1896 and 1914. The rationale for introducing this policy rested on precisely those intuitions that the modern literature has 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. The episode provides 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 autonomy? 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. We believe that these findings shed a new light on the economics of exchange rate bands.

JEL Classification: F31, N32

Suggested Citation

Komlos, John and Flandreau, Marc, Target Zones in History and Theory: Lessons from an Austro-Hungarian Experiment (1896-1914). University of Munich Economics Discussion Paper No. 2003-18. Available at SSRN: https://ssrn.com/abstract=464120 or http://dx.doi.org/10.2139/ssrn.464120

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

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

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