Essays Flashcards
Critically evaluate usefulness of target models in explaining the sterling crisis of the early 1990s. Discuss how econ agents can perceive bands set by the monetary authorities when they are narrow or wide
Intro- ER regimes, currencies fluctuate in bands. CB intervene. UK joined ERM 1990, speculative attacks led to collapse of pound and uk exit from ERM. Credibility, speculative attacks, ER dynamics needs work.
Framework- CB intervene for breaches in upper and lower bands through foreign reserves. Honeymoon effect- less volatile ER near boundaries. S shaped curve, smooth pasting, reduces sensitivity, and provides stability. Foresight and rationality unrealistic. Lacks macro fundamentals and political factors. Intramarginal is when constant intervention throughout band instead of round the edges. Straight line. More confidence etc.
Application- UK joined ERM 1990. ER volatility declined. Pound confidence weakened. Uk recession German boom. Increased inflation uk vs decrease Germany. speculators led by George Soros, shorting pound. Raised interest rates., bought reserves for overvaluation. Confidence collapsed.
Credibility- narrow bands less flexibility leaves currency more exposed to speculative pressure. Acting early CB can reduce doubts in market. Helpful through intramarginal. Wide bands more useful to marginal as ER can adjust more naturally.
Evaluation- intervention occurs at margins. Intramarginal more nuanced understanding of CB stabilising ER and maintain credibility. May not always be feasible due to costs, and depleting reserves too early.
Conclusion- target zones marginal works, especially in analysing bands. Still has limitations as shown from ERM. Could’ve used the more update version of intramarginal which would have meant intervention would’ve happened resilient and could’ve prevented crisis. Other models solve e.g. second model crisis
