The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone

33 Pages Posted: 29 Jul 2015 Last revised: 4 Feb 2016

See all articles by Markus Hertrich

Markus Hertrich

University of Basel - Center for Economic Science (WWZ) - Department of Finance; Deutsche Bundesbank

Date Written: July 28, 2015

Abstract

In the aftermath of the recent financial crisis, the central banks of small open economies such as the Swiss National Bank (SNB) implemented a unilateral one-sided exchange rate target zone vis-à-vis the euro currency to counteract deflationary pressures. Recently, the SNB abandoned its minimum exchange rate regime, arguing that after having analyzed the costs and benefits of this non-standard exchange rate policy measure, it was no longer sustainable. This paper proposes a model that allows central banks and policymakers to estimate ex-ante the costs of implementing and maintaining a unilateral one-sided target zone (in terms of the expected size of foreign-exchange interventions) and to monitor These costs during the period in which it is enforced. The model also offers central banks a tool to identify the right timing for the discontinuation of a minimum exchange rate regime. An empirical application to the Swiss case shows the ex-ante estimated size of these costs and reveals that these costs might have been substantial without the abandonment of the minimum exchange rate regime, which accords with the official statements of the SNB.

Keywords: Foreign-exchange interventions, foreign exchange reserves, minimum exchange rate, reflected geometric Brownian motion, target zone costs, Swiss National Bank

JEL Classification: E42, E52, E58, E63, F33, F45

Suggested Citation

Hertrich, Markus, The Costs of Implementing a Unilateral One-Sided Exchange Rate Target Zone (July 28, 2015). Available at SSRN: https://ssrn.com/abstract=2636748 or http://dx.doi.org/10.2139/ssrn.2636748

Markus Hertrich (Contact Author)

University of Basel - Center for Economic Science (WWZ) - Department of Finance ( email )

Peter Merian-Weg 6
Basel, 4052
Switzerland

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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