Intramarginal Intervention in the EMS and the Target-Zone Model of Exchange-Rate Behavior

Empirical work on exchange-rate behavior under a target-zone regime has used data produced by the European Monetary System (ENS) and has found that the data contradict important predictions made by the standard target-zone model. We argue that the contradictions reflect a misinterpretation of policies pursued by the ENS countries. They intervened intramarginally, to keep exchange rates well within the target zone, rather then intervening at the edges of the zone to prevent rates from crossing them. In the Besle-Nyborg Agreement of 1987, however, the ENS countries agreed to make fuller use of the band, and the effects of the agreement show up strongly in the data. Exchange rates behave differently after the agreement than they did before. The effect appears clearly in the behavior of the French franc and less decisively in the behavior of the Italian lira. The paper concludes by examining and rejecting alternative explanations for the observed differences in exchange-rate behavior.