Misalignments of real exchange rates and the credibility of nominal currency bands

Misalignments of Red Exchange Rates and the Credibility of Nominal Currency Bands. - This paper analyzes a sticky-price target zone model in which rea lignment risk is modeled endogenously as a function of the degree of real e xchange rate misalignments. The implications of the model are used to inves tigate the credibility of selected nominal ERM exchange rate bands. We find that a lack of credibility of the ERM currency bands occurs mostly in coun tries with substantial swings and persistent misalignments of real exchange rates. These findings suggest that the major real appreciations in some Eu ropean bilateral real exchange rates between 1987 and 1992 have been pivota l in triggering the ERM currency crises of 1992 and 1993. JEL no. F31, F33, F41.