Abstract
Like a fixed exchange rate, a target zone system may be subject to speculative attacks when the reserves of the central bank are limited. Thispaper analyzes such speculative attacks and their implications; it shows that the recently developed smooth pasting model of target zones should be viewed as a special case that emerges only when reserves are sufficiently large. The paper then uses the target zone framework to resolve a seeming paradox in predicting speculative attacks on a gold standard, arguing that such a standard may best be viewed as the boundary between one-sided target zones.
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