Is the EMS the perfect fix? An empirical exploration of exchange rate target zones

In the context of a flexible-price monetary exchange rate model and the assumption of uncovered interest parity, we obtain a measure of the fundamental determinant of exchange rates. Daily data for the European Monetary System is then used to explore the importance of non-linearities in the relationship between the exchange rates and fundamentals. While some statistical evidence of non-linearities in conditional means of exchange rates is detected, these seem to have little economic content. A number of implications of existing "target zone" exchange rate models are tested; little support is found for existing models of limited exchange rate flexibility.