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Target Zone Models and the Intervention Policy: The Swedish Case

The intervention policy of the Swedish Central Bank is studied using daily data on all intervention instruments during the late 1980s. In sharp contrast to the first generation Krugman target zone models, it is found that the interventions occur all over the exchange rate band and almost every day. To capture this feature this paper uses a model with continuous interventions that increase in size when the exchange rate moves from some preferred level, implying that interventions not only takes place at the boundaries. This gives a strong mean reverting behaviour of the fundamental. In addition, time varying devaluation expectations are included in the model. The model is then estimated using the method of simulated moments. The results indicate that this model captures the characteristics of Swedish exchange rate data better than the Krugman model. The estimated degree of mean reversion is substantial.