On Evaluating and Extending the Target Zone Proposal Hali J. Edison, Board of Governors of the Federal Reserve System Marcus H. Miller, Institute for International Economics and University of Warwick John Williamson, Institute for International Economics This article examines the target zone proposal for exchange-rate management by presenting the results of simulations performed on both a large macroeconometric model and a small analytical model. The main conclusions derived from the large model are: (1) that exchange-rate-oriented monetary policy could have curbed misa- lignments without undermining counterinflation policy, but (2) a major impact on current balances would have required compensatory fiscal policy as well. The small model suggests the value of assigning world interest rates to the pursuit of a (flexible) world nominal income target and fiscal policy to national nominal income targets, if interest rate differentials are assigned to exchange-rate management. INTRODUCTION One of the authors of the present article has previously advocated a target zone approach to exchange-rate management (Williamson 1985, 1986). His arguments have been verbal and informal. The present paper aims to examine those proposals in a more. formal way, using both large econometric and small analytical models, with a view to both evaluating and extending the proposal. The essence of a target zone system may be regarded as partial assignment of monetary policy to the objective of limiting deviations of the real effective exchange rate (REER) from a target value (~) that Address correspondence to John Williamson, Institute for International Economics, 1! Dupont Circle, N.W., Washington, D.C. 20036 The authors acknowledge the research assistance of Stephen J. Scott. Views expressed are those of the authors alone and should not be attributed to the Federal Reserve Board, other members of its staff, or to other sponsoring institutions. Journal of Policy Modeling 9(1): 199-224 (1987) 199 © Society for Policy Modeling, 1987 0161-8938/87/$3.50