The choice of exchange rate bands: Balancing credibility and flexibility

This paper develops a framework for the optimal choice of exchange rate bands within an environment in which policymakers dislike nominal exchange rate variability, but value the flexibility to adjust the nominal exchange rate in response to shocks, in order to attain real exchange rate objectives. The paper provides an endogenous characterization of the optimal exchange rate band in terms of the underlying distribution of shocks to the current and capital accounts of the balance of payments and in terms of the commitment reputation of policymakers.