Intramarginal intervention in the EMS and the target-zone model of exchange-rate behavior

Abstract

Exchange-rate data produced by the European Monetary System (EMS) contradict important predictions made by the standard target-zone model. We show that the contradictions reflect a misinterpretation of policies pursued by the EMS countries. They intervened intramarginally, to keep exchange rates will within their bands, not at the edges of the bands, to keep rates from crossing them. In the Basle-Nyborg Agreement of 1987, however, they agreed to make fuller use of the band, and exchange rates behave differently thereafter. The effect appears clearly in the behavior of the French franc and less decisively in the behavior of the Italian lira. We conclude by examining and rejecting other explanations for the observed difference in exchange-rate behavior.