Macroeconomic Stabilisation and Intervention Policy Under an Exchange Rate Band

Macroeconomic stabilisation and foreign exchange market interventions are inves-tigated within the context of a stochastic small open economy. With money demand shocks a peg is optimal, but with goods demand shocks a nominal income target is best. With supply shocks the optimal degree of monetary accommodation rises with the welfare weight attached to output rather than to price stability. A nominal exchange rate band is not advisable from a stabilisation point of view, albeit that with money demand shocks no welfare losses are incurred. With goods demand shocks, narrowing the band affects the optimal coefficient of intramarginal monetary accommodation. With supply shocks and no intramarginal interventions, it is desirable to have a wider band if there is a relatively large weight on price rather than output stability