How to run a target zone? : age old lessons from an Austro-Hungarian experiment

This paper considers what we argue was the first experiment of a exchange rate band. This experiment took place in Austria-Hungary between 1896 and 1914. The rationale of introducing this policy rested on precisely those intuitions that modern target zone literature has recently 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. In other words the episode provides us with 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 flexibility? 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