Exchange rate bands and optimal monetary accommodation under a dirty float

This paper studies regimes of managed exchange rates for a small open economy with an integrated capital market, rational expectations in financial markets, sluggish nominal wages and prices, and supply shocks that follow a Brownian motion. Each regime can be characterized by the degree to which price shocks are accommodated and the width of the exchange rate band. Special cases of monetary accommodation are a peg, a clean float and a PPP exchange rate rule. First, the optimal degree of monetary accommodation of price shocks is analyzed when there is no exchange rate band. Second, the effects of exchange rate bands and the accompanying inframarginal interventions are examined when allowance is made for intramarginal interventions as well.