Question

“A target zone system will work only if there is coordination of economic policies among country participants. On the other hand, if this effective coordination of monetary and fiscal policy exists among the members, there is no need for a target zone system!” What is the logic behind this statement?

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Answer 1

ANSWER:-

• The logical of the statement is that coordinated polices would keep real exchange rates stable because counties will not be having incompatible inflationary stances, for example. (This assumes that the inflation differences are not entirely offset by relative purchasing - power - parity exchange rate movements, in which case no cooedinated policies would be necessary).
• However, if the countries have complete inflatinary stances (or if relative PPP holds), there will be no need to specity ceilings and floors since the rates would not vary to any significant extent anyway: a fixed-rate system might as well be used.
• However, proponents of the target zones could say that the target zone system is superior to fixed rates because it provides more leeway in domestic policy, and they could also that PPP tends to hold.

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