Background
A target zone refers to a specified range within which a country aims to maintain its exchange rate relative to either a single foreign currency or a basket of foreign currencies. The target zone framework serves as an intermediary exchange rate regime, blending elements of both fixed and floating exchange rate systems.
Historical Context
The concept of a target zone emerged partly in response to the limitations of purely fixed or floating exchange rate regimes. In the post-Bretton Woods era, countries sought mechanisms to sustain exchange rate stability while retaining some flexibility in monetary policy. Notable instances include the European Exchange Rate Mechanism (ERM), which was pivotal in maintaining relative currency stability within the European Union before the adoption of the euro.
Definitions and Concepts
- Exchange rate: The price at which one currency can be exchanged for another.
- Target zone: A predefined range within which a country’s exchange rate is maintained through central bank policies.
- Intervention: Actions taken by a central bank to influence the exchange rate, which can include buying or selling its currency.
Major Analytical Frameworks
Classical Economics
Classical economics generally supports the idea of minimal government intervention, implying skepticism toward the frequent use of target zones when compared to purely market-determined rates.
Neoclassical Economics
Neoclassical economists may favor target zones if they are seen to stabilize economic conditions without leading to persistent imbalances that require constant intervention.
Keynesian Economic
Keynesian economics would support target zones as a way to provide economic stability, as excessive fluctuations in exchange rates can lead to economic disturbances and reduce confidence in economic policies.
Marxian Economics
From a Marxian perspective, target zones might be viewed skeptically, as they could categorize them as methods through which advanced economies exert control over less-developed economies through favorable exchange rate mechanics.
Institutional Economics
Institutional economists would analyze target zones by considering the broader economic and political frameworks that impact their effectiveness, focusing on the institutions governing the central banks and their policies.
Behavioral Economics
Target zones can also be examined by behavioral economists through models understanding how market participants expect and react to central bank interventions within specified exchange limits.
Post-Keynesian Economics
Post-Keynesian theorists could support well-managed target zones, emphasizing macroeconomic policies that stabilize the broader economy and promote employment and growth.
Austrian Economics
Austrian economists typically advocate for minimal state intervention and might view target zones as distortive market strategies leading to long-term inefficiencies.
Development Economics
In development economics, target zones can play a strategic role in stabilizing emerging market currencies, promoting external investments, and encouraging economic growth.
Monetarism
Monetarists might respect target zones to the extent that they providercknow Ragnar stability, but worry about the long-term sustainability and potential for creating distortions if the underlying economic conditions warrant different exchange rates.
Comparative Analysis
Analyzing target zones implies a balance between the benefits of achieving exchange rate stability and the constraints they may impose on a country’s monetary policy autonomy. Different regions use diverse mechanisms, and their success often varies based on the robustness of local institutions and global economic conditions.
Case Studies
- European Exchange Rate Mechanism (ERM)
- Swedish Krona’s managed float system before joining the Euro
- Exchange Rate Mechanism of the Chinese Renminbi
Suggested Books for Further Studies
- “Exchange Rate Regimes: Fixed, Flexible, and In-Between” by Stanley Black
- “International Economics: Theory and Policy” by Paul Krugman and Maurice Obstfeld
- “Monetary Theory and Policy” by Carl E. Walsh
Related Terms with Definitions
- Floating Exchange Rate: An exchange rate determined entirely by market forces without direct governmental or central bank intervention.
- Fixed Exchange Rate: An exchange rate policy under which a government or central bank pegs its currency’s value to another currency or a basket of currencies.
- Central Bank Intervention: Actions by a central bank to affect the value of its currency by buying or selling foreign currencies in exchange for its own currency.
