Series: Working Papers. 9615.
Author: Enrique Alberola Ila.
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Abstract
Exchange rate targets in a stabilization game are considered. The targeting strategy consists on the choice of a desired level for the exchange and the weight assigned to such target in the loss function. The exchange rate target appears then as an intermediate objective and acts as a surrogate to policy coordination. The targeting solution reveals that the targeting strategy can be embedded on a straight line in the policy-instruments space (the respective money supplies), which greatly facilitates the analysis. It turns out that the targeting strategy is optimal when the reaction of the countries exert a positive externality on the other country. In this case, policymakers have some flexibility in the choice of the target as long as the optimal commitment to such target is selected accordingly.