Abstract
Macroeconomic stabilization and foreign exchange market interventions are investigated for a small open economy with a nominal exchange rate band. In a first-best situation, a band is not advisable from a stabilization perspective, even though 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 restrictions on intramarginal interventions, a band may be desirable. In particular, with supply shocks and no intramarginal interventions, a narrower band is desirable when the central bank attaches a relatively smaller weight to price, as opposed to output stability.
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