THE SIMPLEST TEST OF TARGET ZONE CREDIBILITY

Under the assumption of no arbitrage, the credibility of an exchange r ate target zone is tested by whether domestic interest rates fall with in "rate-of-return bands" between the maximum and minimum home currenc y rate of return on a foreign investment in the absence of a devaluati on. Under the assumption of uncovered interest parity, credibility is tested by whether expected future exchange rates fall within the excha nge rate band. These tests are applied on data on the Swedish target z one from January 1987 through August 1990.