Forward-rate target zones and exchange rate dynamics

A target zone for the forward exchange rate is developed using a log-linear monetary model. Exchange rates are driven by a Wiener process. A central bank purchases or sells foreign exchange forward to keep the target forward rate in a specified band. Defending such a target zone does not require regulated Wiener process, for the central bank's forward exchange intervention can avoid disturbing the money supply. A forward-rate target zone can stabilize the spot rate against a free float and its stabilizing effects become more significant if the delivery term applying to the target forward rate is shorter.