Target zones and international policy coordination

European Economic Review 36 ( 1992) 893-914.

e co

astbetwee Hallett

University of Strathclyde, Glasgow, UK Centre for Economic Policy Research, London,

UK

Received February 1990, final version received April 1990

This payer distinguishes between the necessary and sunicient conditions for adopting exchange rate target zones for improving macroeconomic performance. The necessary conditions are easily satisfied, but it is much more difficult to design a targetting system which satisfies the sufficient conditions when the exchange rate is an intermediate target. On that criterion the gains may be smaller than previously estimated. However, target zones have important practical advantage. They are effective in promoting stability, and as a simple but uncontroversial way of securing the coordination necessary to prevent policy makers adopting inefficient or competitive policies.

Since the creation of the European Monetary System in 1979 and the Louvre Accord in 1987, economists and pohcy makes have debated whether exchange rate management can actually secure better economic performance. Proposals for managing exchange rates via target zones, and arguments for and against the explicit coordination of economic policies, have therefore become central themes in much’macroeconomic analysis. A rapidly expanding literature based on Williamse.jn and Miller’s (1987) target zone ‘blueprint’, and on the Plaza and Louvre policy coordination agreements, testifies to this.’ Correspondence to: Professor A.J. Hughes Hallet, Department of Economics, University of Strathclyde, Curran Building, 100 Cathedral Street, Glasgow G4 OLN, U.K. ‘Examples of this literature will be found in the papers contained in Buiter and Marston (1985) or Bryant et al. (1988). Currie et al. (1989) contains a summary of the main arguments and results. The earlier policy coordination work [e.g. Oudiz and Sachs (1984) Hughes Hallett (1986a)] was not concerned with exchange rate management, but typical references on exchange rate targetting and its role in coordinating economic policy include the Group of Thirty report (1988), Edison et al. (1987a). Currie and Wren-Lewis (1989a,bj. Miller and Weller (1989) Miller and Williamson (1988), Frankel and Goldstein (1986) Hughes Haljett et al. (1989), I-Iorne and Masson (1988).

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0 1992~Elsevier Science Publishers .V. All rights reserved

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In practice, international policy coordination has not progressed beyond the joint targetting of exchange rates. The case for policy coordination and the case for exchange ra:e management are obviously closely related. Some even argue that to say that national economic policies should be coord and that exchange rates should be stabilised are two ways of saying the same thing. That may be an extreme view, but if imbalances in national fiscal and monetary policies cause fluctuations in exchange rates, then coordinating those policies wi:i eliminate the instability. Likewise, targetting appropriately chosen exchang? rate paths will force countries to adjust the fiscal and monetary ~~?~ilicicsto maintain the regime (and the output and inflation targets which o with it) and hence produce a degree of coordination. Of course policy coordination does not mean everyone has to adopt identical strategies. Countries may coordinate in order to reduce the adverse spillovers of ‘beggar-thy-neighbour’ policies [Cooper (1969)], or to capitalise on the locomotive effects of comparative policy advantage, or to improve information flows and the timing of policy changes [Hughes Hallett (1986a)]. On the other hand, targetting an agreed set of exchange rate paths is likely to lead to convergent policies and that would not be helpful if external shocks or market inefficiencies have different impacts in different countries, or if there are different priorities for inflation and output in different countries. Nevertheless exchange rate management might hope to secure a good proportion of the potential gains from coordination, and governments may find it a simple and uncontroversial way of achievi:rd those gains in a complex and uncertain world. In each of these situations policy coordination would not imply rigid exchange rate targetting, but a somewhat looser regime of target zones with controlled realignments and monetary cooperation. Unfortunately the few tests of the target zone proposal which have been undertaken have yielded inconclusive and sometimes conflicting results. Edison et al. (1987a) and Currie and Wren-Lewis (1989a, b), using two different models of the G3 group countries, argue that target zones would have yielded substantial improvements over the historical policies of the 198O~.~ However, that may not tell us very much about exchange rate targetting because the historical policy choices may have been very inefficient. Welfare improvements over history are of course necessary, but not a sufficient condition for accepting target zones. Sufficiency requires that targetting should also improve on the best can be done in the absence of ‘Currie and Wren-Lewis (1989b) write that ‘Although the target zone scheme appears to be highly secsitrve to the exchange targets adopted, i,: welfare enhancing properties do not’ (p. 1781). So target zones may possess a certain degree of robustness. Nevertheless it remains to be seen whether that holds good for other policy regimes and a wider range of models. Edison et al based their conclusions (as we do) on the Federal Reserve Board’s MCM model; Currie and Wren-Lewis use the National Institute’s GEM model.

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strutted by introductually point more to policy instruments - just as Cooper would have argued - than they do to any intrinsic advantages of exchange rate targetting itself. Hence the crucial test is not whether we can beat history, but whether the sufiicient conditions for adopting target zones are likely to be met. In contrast to these tests, Hughes Hallett et al. (1989) found that exchange rate targetting produced gains which are small and badly distributed across the G5 countries. To be able to explain that difference, and in order to evaluate the target zone proposal properly, we have to introduce an appropriate control solution to distinguish the effects of exchange rate management from any improvements which can be obtained simply by boosting the effectiveness of existing policies3 This has not been done before. However, that is not the end of the story. Even if we cannot generate satisfactory improvements over the best that can be done without targetting or cooperation, the failure to do so is not sufficient for rejecting target zones. Governments may well find exchange rate targetting offers a simple way to pick credible and relatively efficient policies, and a way of providing discipline in the face of short term political pressures. This paper therefore sets out to test whether exchange rate targetting is a convenient way of enhancing the effectiveness of fiscal and monetary policy or whether it is an essential part of generating a degree of effective coordination. Sectiam 2 sets out our test procedures. Section 3 reviews ways of setting exchange rate target paths. Sections 4, 5 and 6 provide empirical evidence for the G5 countries in a period which saw the target zone proposal and the Plaza and Louvre agreements (1982-1988). These tests are conducted on the Federal Reserve’s MCM model, but for confirmation we refer to similar results obtained from other models and other objective function specifications. 2. Tests of exchange rate targetting performance 2.1. 7%acontrol solutions Exchange rate targets can affect the policy makers’ expected objectives directly, as well as indirectly via their impacts on other policy variables. It is % order to preserve this distinction we cannot examine simple policy rules as part of the exchange rate targetting mechanism, although the original target zone schemes were specified with simple policy rules in support [Williamson and Miller (1987)]. It could therefore be argued that, despite the unfavourable results which follow, exchange rate targetting is helpful because it makes up for the restrictions implied by using simple policy rules. But that raises a new difficulty. Why, if their deficiencies are really so large as to need repair, should such simple rules be chosen in the lirst place? Intermediate exchange rate targets were certainly not proposed for rescuing simple rules or policy assignments of one kind or another. Any simple rule or policy

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important to make a clear distinction between the case where exchange rate stability is valued as a target in its own right, in which case rate terms are counted as part of the objective function value, an where exchange rate values are merely instrumental in obtainin results for the other targets of interest. In the latter case exchange rate stability constitutes an intermediate target but it has no other significance. The correct comparison is then between the objective function values, net of any losses due to the exchange rate terms, against a benchmark of noncooperative policies without any kind of targetting at either the optimisation or evaluation stages. Thus intermediate targetting includes the exchange rate terms in the optimisation process, but ignores them when evaluating the resulting policies. Those policies must at least dominate the best that countries can do without targetting; i.e. the optimal noncooperative solution which excludes the exchange rate terms at both the optimisation and the evaluation stages.4 If, on the other hand, exchange rate stability were a target in itself then the candidate policies must still be able to beat the best that countries can do without targetting, but they must do so when the exchange rate terms are included in the objective function evaluations. In either case, the outcomes must be incentive compatible. 2.2. Reasons for managing exchange rates Exchange rate targetting can be justified on three main grounds: (a) Foreign exchange markets are particularly

volatile, whereas agents value

assignment will impose constraints on the policy choices, and hence a loss compared to an unconstrained policy choice [Tinbergen (1956)], and it would be quite unfair to count that loss as a necessary part of the exchange rate targetting performance. 41n view of footnote 3 noncooperative policies remain the minimum condition of acceptibiliiy since we are treating intermediate exchange rate targetting as a partial substitute for full cooperation. It might be thought that adding an exchange rate term to the objective function, and then not counting it when evaluating welfare, would automatically reduce welfare compared to a benchmark designed to be optimal for that simpler objective - and that might in turn suggest a simplified policy rule was best. But this is not the case since whether welfare is actually reduced or not depends on whether the sacrifice in other targets (when the extra terms are included) is outweighed by the gains from the reduced conflicts between those targets which is made possible by greater coordination either externally (i.e. the externalities which policy changes in one country impose on the targets of another are reduced); or internally (i.e. the sideeffects of a policy change on targets to which it is not principally assigned are reduced); or because smaller interventions are needed to achieve the same outcomes (i.e. the effectiveness of national policy instruments is increased by eliminating unnecessary competition between countries). In the full cooperation case the answer is clear since there is no extra target but we get all the coordination gains [Cooper (1969), Hughes Hallett (1986a)]. But under exchange rate targetting we have to evaluate that trade-off explicitly since there is a second-best problem underlying it. Once the first-order conditions of a fully cooperative solution have been broken we cannot say whether the exchange rate targetting ‘approximation’ or the optimal noncooperative solution will be closer to the fully cooperative outcome.

(b) An exchange rate agreement is a form of precommitment to consistent policies, and deviations from these policies can be readily monitored in the foreign exchange markets. Exchange rate targetting provides credibility because it is more difficult for errors or policy ‘lapses’ to pass undetected (a credibility or discipline argument). (c) Noncooperative policy making leads to beggar-thy-neighbour policies and competitive appreciations/depreciations. Cooperation would limit those externalities and reduce any fruitless competition, and exchange rate management is a good way of securing the necessary cooperation [a surrogate cooperation argument; Oudiz and Sachs (1984)J The distinction we have drawl, above allows us to examine the first and last of these propositions. The precommitmenr argument has bermstudied in Currie et al. (1987) and the discipline argument by Giavazzi and Pagan0 (1988). 2.3. Noncooperative and cooperative policies This paper considers a world of interdependent trading economies, each possessing two instruments. The noncooperative solutions are simple Nash equilibria. Take the case of 2 countries. Define Yt as the vector of deviations of country A’s targets from their ideal values at time t; Yf”. Then yA’= (YK . *a, y$‘, is the vector of target failures over the decision periods 1. . . , ‘7: Similarly let xA’= (xt’, . . . , x$‘) be the vector of deviations of country A’s instruments from their ideal values. We can now define a loss function: wA= yA'CAyA

+

xA’EAXA,

(1)

where CA and EA are positive definite symmetric matrices. This loss function will be minimised subject to a set of linear constraints:

(2) where RAA and RAB are matrices containing submatrices of dvsamic multipliers, and sA represents the sum of noncontrollable (exoqr,,lous and potentially random) influences on yA. If the instrument valli:s of the other player, B, are treated as given, the first-order conditions y?,ld a set of linear reaction functions:

xA= -(RiAC*RAA+

EA)-'

fAACA/X,BXB + S*).

(3)

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wB=(yB’CBys + xB’EBxe) ence a reaction fu ltaneously with (3) to yi analogous to (3), can be equilibrium is, in general, not ut it is optimal even among the set of possible noncooperative outcomes. an equilibrium in the sense that, if each player presumes the other maker will continue what he is currently doin, D then no-one has any incentive to change policy instruments.’ Cooperative outcomes can be calculated by minimising the ‘collective’ loss function: ave a loss function

w=awA+(l

-a)~~, O
subject to the constraints represented by (2) and its counterpart for yB. The extension of both this cooperative and the noncooperative decision making framework to the case where there are S interdependent countries is straightforward, and it is summarised in Hughes Hallett (I?87a). 2.4.

The MCM model

The calculations in this paper are based on the Federal Reserve Board’s MCM model, a linked system of 5 quarterly national macroeconometric models of the United States, Canada, West Germany, Japan and the United Kingdom. The country models are expenditure based and are linked to ;ach other by equations modelling trade in goods and services, capital flows with perfectly substitutable assets, and flexible exchange rates. MCM is a representative model which has already been used for the empirical analysis of different exchange rate mechanisms: for example the target zone evaluation exercises of Edison et al. (1987a) and Hughes Hallett et al. (1989), and the simulation comparisons in Bryaut et al. (1988). A detailed description of its specification, its properties and a full listing has been published in Edison, Marquez and Tryon (1987b). 2.5. Policy objectives In line with previous studies, we take real output growth (GNP), inflation, the current account balance and the central government budget deficit in each country to be the targets of policy. It is assumed that policy makers in each country will aim for growth in the 3-4% per annum range, inflation rates of approximately l-2% pa, balance on the current account, and “In the absence of any clearly established ‘rules of the game’ the Nash equilibrium has always been adopted a- the appopriate description of noncooperative beh..viour in this literature. We do the same.

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of growth of the national money stocks. Large fluctuations in interest rates are generally perceived to be undesirable because of adverse effects on domestic variables, the exchange rate and international competitiveness. For that reason, movements in short term interest rates are also penalised. For those who regard output growth and inflation as the fundamental targets of policy, it is important to point out that including targets for ;he current accounts, budget deficit and interest rates makes little difference to the expected outcomes for inflation and output. Reducing the priorities on those extra targets, or excluding them altogether, does not change the pattern of the results [Hughes Hallett et al. (1989)]. That kind of insensitivity is a common feature of coordination exercises [Hughes Hallett (1987b)]. Hence constraining the fiscal and trade imbalances does not alter the inflation-output trade-offs facing each country under the targetting compared to the no targetting regime (see table 4 below). But those constraints do play a role in improvmg the inflation-output trade-offs which were available under the historical policy choices. Hence, if removing those constraints makes any difference at all, it will be to extend the gains over history rather than to change tbe comparison between exchange rate regimes. The welfare interpretation of our exchange rate regime comparisons is ther&re not compromised by the presence of the extra targets, although our evaiuafion of them may be biased towards the historical policies. We assume that policy makers would wish to retain these extra targets since they reflect the major imbalances which affected the performance of the OECD economies. Certainly the policy makers at the time thought it important to reduce those imbalances. Perhaps more to the point here, stabilising exchange rates may just transfer competitive behaviour (or other sources of instability) to other variables. Sachs (1986) argues that such instabilities are likely to be transferred to the trade balances, while Hughes Hallett and Minford (1990) find some evidence that stabilising exchans rates destabilises interest rates. It is to avoid further problems of this kind that the extra policy targets have been included. 2.6. The relrltive priorities Obviously exchange rates cannot be treated as either a target or an instrument of policy in the control solutions. But where exchange rate agreements are being tested for their ability so induce cooperative gains, an exchange rate target must be set and some controlling mechanism introduced (usually by setting suitable target paths) in order to simulate the agreement’s provisions. In Hughes Hallett et al. (1989) we looked at a variety of target

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paths to illustrate the ‘;ensivity of economic performance to different exchange rate agreements. We found that the choice of target path was more an securing precise agreement on those paths or on t needed to track them. That means an exchange rate management scheme can be implemented in the form of target zones, but the choice of target paths is more important than the width of the band. In this paper we examine two mechanisms which specify how those target paths should be chosen, with the bandwidth being set implicitly by the penalty assigned to the exchange rate terms. The higher the weight the narrower the band; the lower the weight the wider the band. We are therefore dealing with a case of soft rather than hard boundaries [Williamson and Miller (1987)]. Other constraints on the policy instruments are as follows. It is assumed that policy makers aim to maintain government spending as a constant proportion of GNP (except in the US. where it should fall in line with the Gramm-Kudman targets for 1992) and also a constant growth rate in money supply. Movements from those paths are therefore penalised. However, Canada’s money supply has been endogenised to allow Canadian interest rates to follow U.S. rates. Finally the relative priorities in C’, E’, for i= 1,. . . ,5, are also set out in the appendix. These weights represent a ‘plausible* specification of national preferences, normalised for convenience on the priority for growth in the U.S. The weights specify that a 1% (or percentage point) deviation from the ideal path in any variable would be penalised equally. Growth in Germany and Japan is given a somewhat higher priority, but this is offset in the case of Germany by a higher penalty on inflation. The two U.S. deficits are given priorities which increase over time, so it becomes more important to clear these deficits the longer they persist. All the policy values reported in subsequent sections are ‘open loop’ values computed using the initial (1982) information set. They represent the policy options as they would have appeared when policy makers had to choose whether to go for some kind of exchange rate agreement or not. For the purposes of that calculation the exogenous variables have been set at the OECD’s official forecasts for 1982-1988, as made in 1982. We do not go on to examine what revisions would be made as new information and the scale of errors implied by the original model projection become known. In practice, of course, sequential revisions would be made to the selected strategy, conditional on that new information.

the IJ,S. dollar someway below its 1985 llar starting at the following rates:

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The exercises which follow consider the ossibility of targetting the dollar exchange rate along a srrooothed version of the historical reference path (Appendix A) That path describes a considerably milder appreciation of the dollar (just a few percent per year) against the Yen, Mark and Pound over 1982-1985 than was actually observed, followed by a somewhat greater depreciation over 1986-1988.6 But beyond targetting an agreed exchange rate path with an agreed degree of commitment, countries are assumed to serve their own interests in a Nash game. The point is to see nhether targetting that kind of path produces a better performance than the same exercise with no targetting at all. However there is also the possibility that alternative definitions of the target path would produce better results than a smoothed version of the historical path. According to Feldstein (1988), to target the wrong exchange rate path is likely to produce worse outcomes than basing policy on other considerations and letting the market decide. This is because adopting an extra target necessarily involves some sacrifice in other targets, unless benefits emerge from reduced conflicts elsewhere in the system. It is certainly true that the results may be sensitive to the target paths’ numerical values [Currie and Wren-Lewis (1989b), and Hughes Hallett et al. (1989)]. TO counter these problems we examine two procedures for setting the target paths endogenously. 3.1. Targetting the cooperative equilibrium exchange rate (CEER) One simple if ad hoc procedure is to identify the exchange rate path implied by a cooperative no targetting solution and to use that path as the target in a modified Nash game. The rationale for that .is the follow-i2g. Some of the gains to cooperation may be due to the fact that countries playing a Nash game attempt to manipulate exchange rates to their own advantage. Since one country’s appreciation is another country’s depreciation, these efforts may well be offsetting and, hence, self-defeating. Cooperation eliminates that element of fruitless competition; and as long as countries give some weight to attempting to hit some agreed exchange rate pa.th (whatever else whey do) they will be moderating any struggle over exchange rates. A risk in any targetting agreement is that, if the target path is arbitrarily chosen, it is unlikely to be consistent with countries’ other objectives and therefore attempting to maintain it could reduce welfare. That risk would appear to be small with a CEER path which is consistent with at least one set 6The dollar is targetted against a trade weighted average of the non-U.S. currencies, using the MCM’s own trade-weignts. That appreciation was 8%, 5%, 5%. 1% over 1982-1985; followed by depreciations of 26%. 14% and 5% over 1986-1988.

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of Pareto-optimal outcomes. However we cannot know that an rate which is optimal given unrestricted cooperation will also timal, for the case of partial cooperation. set the CEER’s ability to limit fruitless competition. There are two further drawbacks to this approach. Firstly, it involves simulating a cooperative game which countries are assumed to be unable to play for some reason. For the CEER paths to command assent as a target, countries must jointly have some faith in the economic model used to simulate this cooperation and be prepared to accept the characterisation of their own preferences embodied in the specified utility functions. It may be thought that, if they were prepared to go that far, there would be little preventing them from implementing the cooperative solution itself. Secondly, the fully cooperative equi!ibrium is not unique. There is, in general, a set of such equilibria, each member of which is Pareto optimal but which is characterised by a different distribution of the gains to cc~peration [some of these equilibria were examined in Hughes Hallett (1986b)]. The distribution which emerges will depend on the bargaining process hypothesised. Choice of an explicit bargaining model, or merely making unmotivated assumptions about how cooperation gains are to be distributed, can generate a unique solution and a particular CEER. But there is no assurance that the distribution or the gains, which emerge when the CEER paths are used as targets in the Nash game which follows, will reflect the distribution of the full cooperative equilibrium. Indeed, it is perfectly possible that, while each country would benefit individually from full cooperation, one or more may fail to do so when CEER paths are used to guide a Nash game. At best, a tedious iteration may be needed, examining not one CEER but many, to find one which, when used as a target path, is Pareto superior without the need to invoke a Hicks-Scitovsky compensation principle. At worst, it may be that no CEER exists which produces results in the modified Nash game which strictly dominates the unrestricted Nash equilibrium. 3.2. FEERS and the ARMA updating rule Economic theory suggests that each country should set its exchange rate target path as that path which, in the long run, will ensure zero excess demand for its currency - the so-called fundamental equilibrium exchange rate (FEER) path. While this must be the correct specification for long run economic management, it is by no means clear that the same path is ideal for short run (disequilibrium) problems. In additon there are difiiculties associated with the definition and numerical evaluation (model dependence) of s.’ Thus whatever the theoretical superiority of model projections for ‘See, for example, Williamson and

allets, Target zones and jnte~~QtiovlQ~policy coordination

SK)3

destroyed by itional on the

policy trajectories used in those projections. There is a logical difficulty in assigning certain policy values to make the necessary projections, and then using those projections to generate improvements in those policy values. We need to pick a target path consistent with any desirable policy changes, and policy changes which reflect a desirable target path. In other words, the target paths and policy changes have to be chosen jointly. A simple way to choose target paths and policies jointly, which also allows target paths to react to new information, is the ARMA updating rule: YIAd==c,+d,y,A_d1 +dzy;_l.

The mechanism contains: (i) preassigned elements, c,, describing incremental changes in some fundamental relationship (e.g. CESR or FEER projections); (ii) updating elements, d2yf__I, to revise the ideal path as shocks or information innovations cause the targets to deviate from their projected values; and (iii) smoothing elements, dlyf!r, to dampen any large fluctuations induced by the preassigned elements or random shocks. We can insert (5) into (1) and search for the best d1 and d, values as part of the optimisation process [Ghosh et al. (1987)]. In the absence of acceptable numerical values for the FEERs, we use CEER values for c, in (5).

mpirical results: Intermediate targetting 4.1. Noncooperative (Nash) policies

Table 1 contains the expected objective function values under a variety of noncooperative and cooperative strategies based on the 1982 information set, with and without exchange rate targetting. To test the gains from using the exchange rate as an intermediate target, these objective function values all exclude any exchange rate terms, although the policies underlying the columns marked targetting are derived from an objective which included exchange rate targets Two sets of cooperative results are reported in order to have cooperative solutions which strictly dominate the historical simulation, as well as the noncooperative solutions with or without targetting. The ‘with targetting’ block of the table uses the smoothed version of the model’s exchange rate reference path described in section 3 as the target paths. Finally, results from the CEER and ARIMA schemes are also reported. Table 1 reveals that noncooperative policies, with or without targetting, fail to dominate the baseline (historical) simulation. This is because of a strong performance by Japan in the baseline solution, suggesting that

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Table I Objective function values under different policy rules: The intermediate targetting case.

Country

Baseline

Nash

CoopA

Canada 165.79 120.89 116.89 U.K. 266.40 125.55 125.78 Germany 328.21 159.35 149.56 72.03 69.77 Japan 67.54 U.S.A. L140.89 366.09 339.96

Cooperation substitutes

With tat-getting

No targetting Coop B

Nash

CoopC

Coop D

CEER

ARMA

113.83 125.00 155.41 68.64 343.97

115.11 136.44 166.51 70.21 374.54

110.66 132.81 163.51 50.45 445.90

110.87 134.70 155.08 67.12 367.17

119.26 126.06 159.15 71.64 365.69

119.87 125.62 159.01 71.68 365.39

“Baseline = historical simulation. Nash refers to the optimal noncooperative policies. The cooperative solutions have bargaining weights (ai values) as follows: Coop Coop Coop Coop

A=Canada 0.25, U.K., 0.19, Germany B =Canada 0.26, U.K., 0.24, Germany C=Canada 0.20, U.K., 0.15, Germany D=Canada 0.27, U.K., 0.18, Germany

0.11, Japan 0.08, Japan 0.05, Japan 0.10, Japan

equilibrium

0.25, U.S.A. 0.23. 0.22, U.SA. 0.20. 0.50, U.S.A. ;).!O. 0.22, U.S.A. 0.23.

Coop A is the first stage of the CEER procedure; Coop B dominates Nash no targets; Coop C dominates the baseline simulation; Coop D dominates Nash with targetting. The ARMA scheme sets c, at the incremental CEER target path values and d = 1 except for Canada (d=0.6) and the U.K. (d =0.55).

Japanese policies in the 1982-1988 period were well chosen compared to rather poor U.S., U.K., German and Canadian policies.* In fact, Japan apart, the gains over nistory are pretty large. Table 2.a shows that the U.S. gains 67% in ‘welfare’ units; Germany and the U.K. both gain about 50%; Canada gains about 28%; while Japan loses around 5%. Those gains are worth the equivalent of 104% extra GNP growt per annum for the U.S. (all other variables fixed at their baseline vslues), 4&, extra GNP growth for the U.K., 34% for Germany, 23% for Cana&, and - 13% for Japan.g However, the interesting thing about these results is that targetting seems to matter very little; the gains are virtually the same whether we adopt exchange rate targets or not. Thus targetting without cooperation may have minor distributional effects (the U.S., U.K. and Germany are slightly worse off in table 1, while Japan and Canada benefit), but the real lesson from these calculations is that we need to increase the effectiveness oi conventional fiscal and monetary policies. Since that can be done almost equally well with or *This strong performance by Japan on the baseline solution is also very clear in the GEM model results reported by Currie and Wren-Lewis (1989b). Wren-Lewis (1987) attributes this to the fact that Japan was -IV:ady targetting its exchange rate in this period. Presumably that gave Japan an advantage whicir, in view of the losses in table 2.a, would be lost when the other countries start to do the same. ‘This growth rate measure was suggested by Oudiz and Sachs (1984) and has been widely used for ‘evaluating’ the gains from policy c, ordination. The measure is defined as the increase in output grow?h that would supply the same objective function gain as observed, other policy variables being fixed at their baseline values,

Qktt,

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irrr_‘mationa~p~ky

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o with targetti

p-O-

4.2. Cooperative policy making is what matters It is comparatively easy to find cooperative policies which dominate the baseline simulation, inclusive of the good Japanese historical performance. Both cooperative targetting solutions do so [columns 5 and 6 of table 2.a], and the cooperative solution without targetting in column 3 nearly does so. These results show that targetting is rather more powerful in a cooperative framework - most obviously for Japan and, to a lesser extent, for the U.S. But it is still relatively unimportant for Germany, Canada and the U.K. With targetting, Japan gains 25% over history, the U.S. 61%, Germany and the U.K. 50”/,, and Canada 33%. If the criterion of success is a Nash bargain, we should pick the policies underlying the outcomes in column 5 since they maximise the product of the gains over the baseline. The only other sustainable bargain, in the sense of dominating the baseline policies, is ‘COOP D’ in column 6; the cooperative solutions without targetting (‘COOP A’ and ‘COOP B’) are both unsustainable although they product significant Table 2.a The welfare gains oker the baseline historical simulation from table 1: The intermediate targetting case (% reductions in expected objective function values). Strategy

No targetting

Cooperation substitutes

With targett’.lrt;

Country

Nash

CoopA CoopB

Canada U.K. Germany Japan U.S.A.

27.1 52.9 51.4 -6.6 67.9

29.5 52.4 54.4 -3.3 70.2

31.3 53.1 52.6 -1.6 69.9

Nash 30.6 48.8 49.3 -4.0 67.2

Cobpi:

Coop D

33.3 so.1 so.2 +25.0 60.9

33.1 49.1 52.7 +O.l 67.8

CEER 28.1 52.7 51.5 -6.1 67.9

ARMA _~ 27.7 52.8 51.6 -6.1 67.9

“The different strategies are defined LI table 1.

Table 2.b The welfare gains over the best noncooperative no targetting solution from table 1: The intermediate targetting case (% reductions in expected obiective function values). -Cooperation ;,!>xtitutes With targetting No targetting Strategy ~__. L’EER ARMA Coop C Coop D Nash Coop A Coop B blash Country Canada U.K. Germany Japan U.S.A.

0 0 0 0 0

+ 3.3 -1.0 +6.1 +3.1 +7.1 __..____-

+ 5.8 + 0.4 + 2.5 + 4.7 + 6.0

+4.8 -8.7 -4.5 +2.5 - 2.3

+8.5 - 5.8 -2.6 + 30.0 +21.8

+ 8.3 -7.3 +2.7 +5.8 -0.3

+ 1.3 -0.4 +Q.1 +o.s -0.1

+0.8 -0.1 +O.l + 0.5 +0.2 --

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Target zones and international

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gains for some countries. Thus, because of Japan’s superior policies in this riod, targetting appears to be important for sustainability. two things going on here; targetting and cooperation. Unde alone, the U.S. gains Xl%, Germany and the U.K. 53% and Canada 31%. Hence it is cooperation, rather than targetting, which is doing most of the work. 4.3. Partially cooperative solutions: the CEER and ARMA schemes

The CEER/ARMA schemes perform well compared to the historical baseline and produce results which are fractionally better than the ‘noncooperative - no targetting’ outcomes. Thus although these solutions still do not dominate the baseline because of the good Japanese performance there, they do capture most of the cooperative-targetting gains of the Nash bargain. The results described in sections 4.1 and 4.2 suggest that, Japan apart, exchange rate targetting itself may have rather little impact on economic performance compared to conventional measures for improving the effectiveness of fiscal and monetary policies. Tabie 2.b confirms this by showing small gains, and several losses, when different targetting and cooperative strategies are compared to noncooperative-no targetting policies. In fact the gains in table 2.b are mostly less than one tenth of the gains in table 2.a. Moreover the dominance pattern has shifted. The targetting strategies no longer dominate the best ‘noncooperative-no targetting’ outcomes, but cooperation without targetting now does so [table 2.b, col. 3)]. Thus targetting does not produce results which arc sustainable for courltries who take the trouble to check on the best they could do without either cooperation or targetting. Historical comparisons create the illusion that targetting would bring large welfare gains when their real advantage lies in limiting the damage done by poor policy choices. 4.6. The robustness of intermediate tar-getting as a cooperation substitute The unavoidable conclusion of this section is that exchange rate targetting itself contributes very little that cannot be achieved by other means - and that those contributions may sometimes even be negative. Yet it would be quite wrong to take these results as a condemnation of exchange rate targetting as a policy device. Both the CEER and ARMA targetting schemes produce good results in table 2.b. Apart from very small losses for the U.K., they both dominate the ‘noncooperative-no targetting policies’ even if they do not capture much of the gains of the cooperative strategies. And they o better tban any of the other schemes in the sense that the U.S., U.K.

A..!. Hughes

allerr,

Target zones and

international policy coordination

907

r any losses eve

That degree of robustness shows that a noncooperative regime constrained to target cooperatively chosen exchange rate paths can be used to rule out the ineffective and conflicting national policies found in the historical baseline, although some fine tuning of those paths may be needed to clear up any unwanted dstributional consequences. bxchange rate targetting therefore provides a useful ‘safey net’. It offers policy makers a simple way of preventing ineffective, myopic or undesirably competitive policies. In terms of the propositions put forward in section 2, that means the principal advantage of exchange rate targetting is as a simple rule for generating ‘good’ policies which satisfy the need for credibility and discipline. But targetting is not an essential step for securing : :h properties. Much of the same performance can be obtained wii. jut any targetting at all. Moreover the ‘good’ policies are not optimal; exchange rate targetting substitutes rather badly for the desirable but politically difficult fully cooperative policies. So while the ‘safety net’ is important for establishing credibility and discipline, there are few gains in efficiency over what can be achieved by well designed policies without targetting. 5. Targetting when exchange rate stability is an objective

The fourth potential benefit of exchange rate management is greater stability in the foreign exchange markets. Tables 3.a and 3.b present the gains of various strategies over the historical simulation and Qver the best noncooperative (no targetting) solution when the exchange rate terms are kept in the objective function during both optimisation and evaluation. The minimum condition for acceptability is that targetting schemes should do better than the best ‘noncooperative-no targetting’ policies evaluated through this extended objective. Table 3.a The welfare gaits over the baseline simulation when exchange rate stability is an objective in itself: Y0reductions in expected objective function values (corresponding to table La).’ Strategy Country Canada U.K. Germany Japan U.S.A.

Nash 26.2 18.2 42.8 -65.3 65.9

Coop A CoopB 28.5 23.7 46.0 -44.8 68.4

Cooperation substitutes

With targetting

No targetting 30.3 25.3 44.2 - 42.4 67.9

“The strategies are delined below table 1.

Nash 29.8 25.7 43.6 -48.5 65.9

CoopC 32.3 43.1 49.0 + 17.9 60.4

Coop D 32.0 36.5 49.6 - 17.6 67.0

CEER 27.2 20.5 43.6 -64.1 66.0

ARMA 26.8 19.4 43.5 -61.9 66.5

.,?..I. Hughes

908

Hallett,

Target

zones and international

policy

coordination

Table 3.b The welfare gains over the best noncooperative rto targetting solution when exchange rate stability is an objective in itself: “/a reductions in expc:ted objective function values (corresponding to table 2.a).” Strategy

Cooperation substitutss

With targetting

No targetting CoopA

CoopB

Nash

CoopC

Coop D

CEER

ARMA

0 0

3.0 6.8

5.6 8.7

5.1 10.2

8.2 0.5

7.8 22.4

1.4 2.8

0.9 1.5

0 0

12.3 5.5 7.4

13.7 2.4 6.0

11.2 1.4 0.1

50.3 10.8 - 15.9

28.8 11.8 15.0

;: 0:5

:‘: 2:o

Country

Nash

Canada U.K. Germany Japan U.S.A.

Similar res:llts emerge as in the intermediate targetting case, but with some notable differences. The gains in table 3.b are still much smaller than those in table 3.a. That means the improvements are once again coming from increasing the effectiveness of fiscal and monetary policies. But this time targetting does outperform no targetting under both noncooperative and cooperative policies. Cooperation also outperforms the corresponding noncooperative policies more easily in table 3.b than it did in table 2.b. However, neither the CEER nor the ARMA schemes turn in a strong performance since the opportunity to revise target tracks allows exchange rates greater flexibility. Under this stability objective, CEER type schemes are poor substitutes for full coordination. From this we may conclude that comparisous with history will still be misleading. Interestingly the gains over the historical baseline are now smaller by 10% for Germany compared to table 2.a and by 30% for the U.K., while the losses to Japan under optimal have increased ten-fold. A desire for stability thus makes it more important that policies are well designed. and an easy way to do that is to use exchange rate targets. olicy settings under targetting and coo How does exchange

rate targetting affect the optimal policy values for each country? Average values of the cooperative and uncooperative policies, and their expected outcomes for 1982-1988, are given in table 4. For comparison we also report the historical simulation values. The biggest changes appear, as expected, in the form of policy improvements which can be made simply by adjusting the conventional fiscal and monetary instruments without any targetting. Comparing the baseline and ncooperative-no targetting’, we find the U.K. should tighten its monetary licy largely untouched), while Germany should monetary policies quite a lot (but with mere e). Japan, in contrast, s ould aIs0 expa but

-

Table 4 Average policy values (1982-1988) under different targetting and ~ontargetti~g strategies.a Jap.

U.S.A.

Historical baseline GNP

P cl3

GDEF

ER RS

G M

3.19 5.28 -3.27 24.35

0.52 10.21 20.01 5.00

3.28 1.99 5.20 2.06 -0.27 49.61 7.76

28.44

4.71 -1.11 10.66 5.56 20.96 19.91 18.38 6.14

ER RS G M

2.74 4.27 - 3.64 15.06 -0.00 6.48 19.30 5.00

2.07 2.40 - 3.79 4.76 11.25 9.79 19.93 15.62

3.56 2.41 22.86 45.66 10.53 4.90 22.37 8.19

3.65 1.01 6.22 9.86 16.47 5.30 9.75 8.02

Ger.

Jap.

U.S.A.

- 3.84 7.83 19.90 3.79

1.20 1.49 - 44.42 79.64 - 9.94 3.43 18.05 10.81

Cooperation with targetting (Coop D) 1.28 3.30 2.18 3.68 4.07 0.93 4.18 2.37 1.89 1.31 -2.71 20.32 6.04 -45.38 -497 87.69 17.89 4.95 48.42 8.97 8.46 9.40 13.31 -8.85 - 0.02 3.93 7.30 10.08 5.24 5.47 18.24 19.94 20.31 22.28 9.57 9.54 5.00 15.38 7.08 7.92

Noncooperative with targetting GNP P CB GDEF

U.K.

Noncooperative-no targetting 2.74 2.01 3.54 1.22 3.51 4.63 2.01 2.32 1.78 0.93 - 3.63 - 4.49 22.07 6.43 -41.88 15.07 10.75 47.34 10.78 76.76 14.26 12.18 17.92 - 11.60 - 0.08 3.36 6.43 10.13 5.18 5.42 17.96 19.26 20.45 22.43 10.00 11.20 5.00 14.37 7.57 7.73

4.11 3.04 1.30 3.85 9.13 - 100.45 11.44 175.21 9.10 5.80 9.78 6.14

Czln

“GNP in % growth p.a.; P = price inflation in % p.a.; CB = curren! balance and GDEF = budget deficit, both in billions of domestic currency (Japan trillions); ER=exchange rate changes in % p.a.; RS=short-term interest rates (3 month Treasury Bills); G = government expenditures as % of GDP, M = rate of growth of money stock (MI) p.a.

by less and mostly in monetary terms; and the U.S. should alter its fiscalmoneta-y znix by expanding the money stock while contracting government expenditures quite sharply. None of these changes are particularly controversial given the conventional critique of the policies adopted by the 63 countries during this period. Many of the policy changes are directed at speeding up the adjustment process. We find that Canadian and U.S. interest rates should have fallen, opening up negative differentials with Germany, Japan and the U.K., and thereby creating the conditions which could have prevented the sharp appreciation of the dollar while continuing to encourage its depreciation after 1985. These interest rate differentials are achieved by the alterations in the policy mix in the 63 countries. Simultaneous fiscal and monetary expansions in Germany and Japan leave their interest rates unchanged while boosting domestic demand and putting downward pressure on their trade surpluses. The U.S.‘s combination of fiscal contraction and monetary expansion reduces its interest rates sharply without adding anything to domestic demand and its trade deficit. As a result the 1J.S. dollar depreciates three ark and Yen double their dollar values times as fast, while the Pound,

910

A..!. Hughes Halktt.

Target zones and international

policy coordination

compared to the baseline. At the same time the German and Japanese cumulative trade surpluses are halved, and the U.S. trade deficit is more t alved, while the U.K. moves into deficit. 411 these adjustments look pretty satisfactory and they explain why the major gains come from improvements in the conventional fiscal and monetary policies rather than from exchange targetting. That is to say the main adjustments appear in the historical comparisons and not between exchange rate regimes. Table 4 shows a shift in monetary and fiscal policies, with or without exchange rate targetting, which produces some realignmems in the exchange rates, smaller trade imbalances, and a redistribution of the fiscal deficits to Europe. Moreover output growth, at 2-3x, is slower everywhere except Germany than in the historical simulation, while inflation is also down - rather little in Canada, Japan and Germany, but satisfyingly more so in the U.S. and U.K. These new policies are therefore suggesting some movement along the international Phillips curve in favour of lower growth and less inflation, and that Germanys anti-inflation stance is acting as a brake on the whole system. But the feature of greater interest in tabie 4 is that exchange rate targetting itself does not call for any major changes in the policy settings in any country. Under targetting there is a small shift in the UK’s fiscal and monetary mix, with some fiscal contraction and monetary expansion in order to modify the Pound’s appreciation compared to the no targetting case. Germany also has a more expansionary monetary policy in order to restrain the Mark’s appreciation. The remaining policy changes are minimal. The upshot is smaller currency adjustments; worse trade and budget deficits in the U.S.; and reduced budget and trade imbalances in the U.K. and Japan. But these are small changes compared to the historical comparisons. The key is therefore to choose better balanced fiscal and monetary policies. Exchange rate targetting may be an easy way of doing that, but it is not an essential component since almost the same results can be obtained without targetting. A further conclusion is that targetting does not call for any significant changes in the underlying instrument settings of the kind that one would expect if fiscal and monetary policy assignments were needed in a regime of exchange rate targets. On the contrary, targetting appears to induce c: greater measure of coordination, both bet n countries and between fiscal and monetary policies within countries. r example, with the loss of ‘internal coordination’ under an assignment regime, one might have expected a loss of effectiveness and hence stronger policy interventions to be necessary on average [see Cooper (1969)]. But this has not appeared. Similarly one would expect assignments to lead to overshooting and oscillations in the targets because the side-effects of each policy change are ignored till after they have happened. That would im ly greater variabili in the instrument values in an attempt to correct th t overshooting be viour - but that does not

Table 5

The standard deviations of fiscal and monetary interventions under different strategies (computed 3982-1988).

Canada U.K. Germany Japan USA

Nash no. targetting

Nash with targettiag

Cooperation with targetting (Coop D)

bti

CG -___ 0.50 0.87 0.61 0.56 2.00

% -.0.26 0.47 i.04 0.62 1.79

0.52 0.8,” 0.60 0.54 2.04

bh( ___0 O&l 1.75 0.65 8.81

dlrl 0 0.:9 1.48

0.66 8.39

%Sf 0 0.57 1.52 2.41 4.85

happen either. If anything there is a greater policy stability. Table 5 contains the time series standard deviations of the policy instruments under each strategy.) Coordination likewise permits greater continuity in the policies because it removes the ‘national’ assignments of instruments to targets.” None of this is of course a conclusive test of the wisdom of introducing policy assignments, but it is strong evidence that the policy mechanisms which are appropriate for conventional policy problems are also appropriate for targetting regimes. Assignments are not needed.

7. Conclusions In this paper, we have examined the effect of exchange rate targetting on economic performance in the larger industrial economies. We find important gains over the historical performance, just as Currie and Wren-Lewis (1989a, b) did. However that is a necessary condition, but not sufficient for accepting the target zone proposal. Tests of the sufficient condition require a properly constructed control solution as a point of comparison. Historical simu!ations are not appropriate because they cannot distinguish improvernems due to exchange rate targetting from the gains which could be made by increasing the effectiveness of existing policy instruments. That is our first point. We in fact found that exchange rate targetting contributed only about onetenth of the gains achieved over the historical simulation - the rest came from improved fiscal and monetary policies in the absence of targetting This result has been achieved despite constraints on the use of instruments which are as strong as those on the targets. That suggests our conclusions will be robust to the policy makers’ usual desire to restrict fiscal interventions. fact the main contribution of targetting has been greater stability; remove the targetting mechanism and the exchange rate changes become as much as “See Hughes Hallett (1986a).

A..!. Hughes Halktt,

912

Target zones arid international

policy coordination

age) with only a mild deterioration in the ence - and this is o r second conclusion 0 concentrate on improving t devoting a great deal of effort to chasing certain However exchange rate targetting has other important advantages which may be sufftcient for adopting target zones. It offers policy makers a useful ‘safety net’; an easy way of preventing inefficient or unnecessarily competitive policy choices. Indeed the main advantage of exchange rate targetting is that it offers any easy and visible way of increasing the effectiveness of conventional policies, Full optimisation, without targetting, is a more complicated way of getting the same result. In that sense targetting satisfies the need for credibility and discipline. This paper does not argue that policies should follow simple rules for reasons of credibility since the results suggest such rules, at least in the form policy assignments, are unlikely to be successful (and hence credible) because of the evident need to coordinate the mix between fiscal and monetary policies. However, conclusive tests have not been performed and policy makers who regard simplicity and credibility as effectively synonomous may wish to see further evidence on that issue. That would be an important ex,:r$on to bhis paper. Targetting may however be helpful in two other ~~+:ts. First it may be helpful for correcting a poor distribution of the gains from using conventional policies more effectively. Second, targetting is clearly helpful when exchange rate stability is regarded as a target in its own right. Any resi:lts of this kind depend on the particular model and objective functions uses’ and further research is needed to check on their robustness. owever exchange rate targetting exercises with a different model (the National Institute’s GEM model) have yielded very similar results for the G3 countries. The szme story emerged when the exercises were repeated, in a slightly different form, on the LINK and MINIMOD models (the latter has forward looking expectations).” Hence the obvious objection that our conclusions are model specific, in the sense of being highly sensitive to the choice of model used to evaluate the various policy regimes, appears to be invalid in this case. Similarly, extensive alterations to the relative priorities on the exchange rate terms, on the preferences for low inflation vs. output growth, and on the priority for reducing external imbalances (including removing that tar@) failed to change the conclusions. So, even if some quantitative differences lo emerge, it seems unlikely that these results would be changed are qualitatidy had a different model and a different objective function been used.

’ 'See

ughes

dktt

et al. (1989) for these results.

913

Table 1

The objective function specification.” Canada

U.K.

Germany Japan

U.S.A.

The ideal values

GNP lj GDEF CB ER RS G M

5.0 2.0

4.5 3.0

4.0 1.5

5.0 1.0

10.0 0.c)

0.0

15.0 0.0

5.0 0.0

4.5 2.0 5::

baseline simulaiion values (see text) 7.5 20.0 12.0

4.0 20.0 5.0

4.0 9.0 5.0

6.0 20.0 7.0

1.0 1.0

2.0 2.0

2.0

1.0 1.0

0.08

0.05

0.01 0.1

0.01 0.1 1.0 1.0 1.0

0.01 0.01 0.1 1.0 1.0 1.0

7.0 20.0 5.0

The relative priorities GNP P CB GDEF ER RS

G M

1.0 1.0

1.0

1.0 1.0

1.0 0.01 0.01 0.1 1.0 1.0 1.0

0.01 0.01 0.1 1.0 2.0

1.0

‘Units: GNP, P, ER, M in % changes p.a. CB, GDEF in billions of domestic currency (Japan, trillions). G expressed as % of GNP. RS in % points. Both RS and ER are nominal values.

eferences Earrell, R. and S. Wren-Lewis, 1989, Fundamental equilibrium exchange rates for the G7, Discussion paper no. 327 (Centre for Economic Policy Research, London). Bryant, R., D. Henderson, G. Holtham, P. Hooper and S. Symanski, eds., 1988, Empirical macroeconomEcs for interdependent economies (Brookings Institution, Washington, DC). Buiter, W.H. and R.C. Marston, 1985, eds., International economic policy coordination (Cambridge University Press, Cambridge). Cooper, R.N., 1969, Macroeconomic policy adjustment in interdependent economies, Quarterly Journal of Economics 83, l-24. Currie, D.A., G. Holtham and A.J. Hughes Hallett, 1989, The theory and praciice of international policy coordination: Does coordination pay?, in: R. Bryant, D. Currie, J. Frenkel, P. Masson and R. Portes. eds., Macroeconomic policies in an interdependent world (IMF, Washington, DC). Currie, D.A. and S. Wren-Lewis, 1989a. Evaluating the blueprints of the conduct of international macropolicy, American Economic Review 79, 264-269. Currie, T).A. and S. Wren-Lewis, 1989a, An appraisal of alternative blueprints for international policy coordination, European Economic Review 33, 1769-1786. Currie, D.A., P. Levine and N. Vidalis, 1987, Cooperative and noncooperative rules for monetary and fiscal policies in an empirical two-bloc model, in: R. Bryant and R. Fortes, eds., Global macroeconomics: Policy conflict and cooperation (Macmillan, London).

914

A../. Hughes Halletr, Target zones and international policy coordinarion

Edison, H., M.H. Miller, and J. Williamson, 1987a, On evaluating and extending the target zone proposal, Journal of Policy Modelling 9, 199-224. Edison, H., J. Marquez and R. Tryon, 1987b, The structure and properties of the Federal Reserve Board Multicountry Model, Economic Modelling 4, 115-315. ., 1988, Let the market decide, The Economist, Dec. 3, 1988, p. 21. Feldstein, Frankel, J.A. and M. Goldstein, 1986, A guide to target zones, IMF Staff Papers 33,633-670. Ghosh, S., C.L. Gilbert and A.J. Hughes Hallett, 1987, Stabilising speculative commodity markets (Oxford University Press, Oxford). Giavazzi, F. and M. Pagano, 1988, The advantage of tying one’s hands: EMS discipline and central bank credibility, European Economic Review 32, 1055-1082. Group of Thirty, 1988, International macroeconomic policy coordination, Group of Thirty Report (New York and London). Horne, J. and P. Masson, 1988, Scope and limits of international economic cooperation and policy coordination, IMF Staff Papers 35, 259-296. Hughes Hallett, A.J., 1986a, Autonomy and the choice of policy in asymmetrically dependent economies, Oxford Economic Papers 38, 516544. Hughes Hallett, A.J., 1986b, International policy and design and the sustainability of policy bargains, Journal of Economic Dynamics and Control 10,4b7-494. Hughes Hallett. A.J., 19873, The impact of interdependence on economic policy design, Economic Modelling 4, 377-396. Hughes Hallett, A.J., 1987b, How robust are the gains from policy coordination to variations in the model and objective function, Ricer&: Edonomiche 41, 341-372. Hughes Hallett, A.J., G. Holthsm and G. Hutson, 1989, Exchange rate targetting as surrogate international policy coordination, in: B. Eichengreen, M. Miller and R. Portes, eds., Blueprints for exchange rate management (Academic Press, New York). Hughes Hallett, A.J. and P. Minford, 1990, Target zones t :d exchange rate management: A stability analysis of the European Monetary System, Open t-.b;onomiesReview 1, 175-200. Kenen. P.. 1988. Manapine exchange rates I Routledge. London). Miller, M.H. and P. Weller, 1988, Solvin r; stochastic saddlepoint systems: A qualitative treatmen! with economic applications, Disr:ussion paper 308 (Centre for Economic Policy Research, London). Miller, M.H. and J. Williarnson, 1988, The International Monetary System: An analysis of alternative regimes, European Economic Review 32, 1031-ic154. Oudiz, G. and J. Sachs, 1984, Macroeconomic policy coordination among the industrial economies, Brookings Pa.pers on Economic Activity 1, l-64. Sachs, J., 1986, The uneasy case for greater exchange rate coordination. American Economic Review 76, 336-341. Tinbergen, J., 1956, Economic policy: Principles and design (North-Holland, Ams!erdam). Williamson, J. and M.H. Miller, 1987, Targets and indicators: A blueprint for the international coordination of economic policy (Institute for International Economics, Washington, DC). Wren-Lewis, S., 1987, Introducing exchange rate equations with a world econometric model, National Institute Economic Review 119.