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Volkswirtschaft - Open Access LMU - Teil 01/03 Podcast
Target Zones in History and Theory: Lessons from an Austro-Hungarian Experiment (1896-1914)

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

Volkswirtschaft - Open Access LMU - Teil 01/03 vor 23 Jahren

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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.