Chapter 36 The operation and collapse of fixed exchange rate regimes

This chapter discusses the operation and collapse of fixed exchange rate regimes. It reports recent research contributions to the understanding of the dynamics of a fixed exchange rate system. These contributions can be placed readily into two categories research on target zones and research on speculative attacks on fixed exchange rate regimes. The chapter briefly discusses the various rationales for selecting a fixed exchange rate system over a floating exchange rate regime. The focus, however, is on the positive economics of fixed exchange rates. This focus is consistent with most of the research in the past decade; given that a target zone or fixed exchange rate system is chosen, researchers have concentrated mainly on determining its dynamic development. Although, as the chapter reports, much empirical research has been done to examine theoretical models, the recent literature is primarily a theoretical one. Most research in this area is based on the simple monetary model of the exchange rate, which does not perform well empirically in the short run. Nevertheless, this literature has had great influence in central banks, given the background of the existence of important target zone systems and of major exchange rate crises in the past decade.