Fixing Exchange Rates

Abstract

This paper examines the distinction between two definitive exchange rate fixing rules: a “time-dependent” rule according to which the exchange rate is fixed at an arbitrarily given date, and a “state-determined” rule according to which the exchange rate is fixed when the fundamental variables have reached a certain threshold. By analyzing them together, we will show how these two strategies are in fact strictly equivalent if the fundamentals follow a purely deterministic process during transition. In a broader stochastic context, a correspondence in probabilistic terms prevails between these strategies. Analyzing these two systems together is a useful first step toward a fresh analysis of the Maastricht exchange rate strategy and helps shed light on certain aspects of the scenario which the European authorities decided to adopt.

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