Target zone models Flashcards

1
Q

Why is there no such thing as a truly fixed exchange rate

A

There is no such thing as a truly fixed exchange rate, because most currencies are allowed to float between certain bands in the real world.

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2
Q

What is a recent real world example of real world currency bands?

A

A recent real world example of real world currency bands is the EU currency zone in the European monetary system

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3
Q

What do target bands depend on?

A

Target bands depend on the economic condition and goals of the country.

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4
Q

Under the BW system, currencies were allowed to fluctuate by…

A

Under the Bretton Woods system, currencies were allowed to fluctuate by 1% above or below the specified rate

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4
Q

Under the BW system, currencies were allowed to fluctuate by…

A

Under the Bretton Woods system, currencies were allowed to fluctuate by 1% above or below the specified rate

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4
Q

Under the BW system, currencies were allowed to fluctuate by…

A

Under the Bretton Woods system, currencies were allowed to fluctuate by 1% above or below the specified rate

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5
Q

Under the BW system, currencies were allowed to fluctuate by…

A

Under the Bretton Woods system, currencies were allowed to fluctuate by 1% above or below the specified rate

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6
Q

What is a target zone?

A

A target zone is a specified numerical area within which a currency is allowed to fluctuate

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7
Q

What is an example of an expectation caused by a target zone?

A

An example of an expectation caused by a target zone is that when a currency exchange rate approaches an upper or lower band, there is an expectation that the monetary authority will step in

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8
Q

What happens when exchange rates hit the edge of a band?

A

When exchange rates hit the edge of a band, the currency becomes a fixed exchange rate

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8
Q

What happens when exchange rates hit the edge of a band?

A

When exchange rates hit the edge of a band, the currency becomes a fixed exchange rate

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9
Q

If agents are … … then this should affect the behaviour of the exchange rate within the band

A

If agents are forward thinking, then this should affect the behaviour of the exchange rate within the band

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10
Q

What does the monetary authority do to prevent the rate from hitting the top band?

A

To prevent the rate from hitting the top band, the monetary authority reduces the money supply to cause the exchange rate to appreciate

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11
Q

What does the monetary authority do to prevent the rate from hitting the bottom band?

A

To prevent the rate from hitting the bottom band, the monetary authority increases the money supply to cause the exchange rate to depreciate

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12
Q

As long as the exchange rate remains within the …, the money supply will remain …

A

As long as the rate remains within the band, the money supply will remain unchanged

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13
Q

What is marginal intervention?

A

Marginal intervention is when the monetary authority steps in to prevent the currency from depreciating or appreciating to a level where it reaches a top or bottom band

14
Q

In the presence of exchange rate bands, exchange rate behaviour is described by an … shaped curve

A

In the presence of exchange rate bands, exchange rate behaviour is described by an S shaped curve

15
Q

Why does the honeymoon effect occur?

A

The honeymoon effect occurs because as the currency approaches the top or bottom bands, the markets expect the authority to step in, so they will buy or sell the currency accordingly, causing it to restore equilibrium levels without the authority having to actually carry out any action.

16
Q

What are the two assumptions of the basic target zone model?

A
  • The currency bands are completely credible

- Authorities will step in to enforce the bands

17
Q

When tested using real world data, marginal interventions appear to be the … rather than the …

A

When tested using real world data, marginal interventions appear to be the exception rather than the rule

18
Q

What is the difference in probability of hitting the edge of the band under intramarginal intervention?

A

Under intermarginal intervention, the probability of hitting the bands is much lower than marginal intervention

19
Q

Why does the curve have an S shape?

A

The curve has an S shape because as the exchange rate approaches the band, the authorities will step in and intervene, causing the currency to depreciate or appreciate at a slower rate, leaving us with an S shape.