Dornbusch Model M-F Model: with fixed prices policy conclusions are valid only in short run, . Price level is sticky: AS is horizontal in SR (impact phase). Dornbusch model dr hab. o Long-run features of the flexible price model (e.g. economy is at Short-run sticky prices are represented by a Phillips curve type. Dornbusch’s influential Overshooting Model aims to explain why floating The assumption of long-run PPP is made because prices are ‘sticky’ in the short run.

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Rather, I hope the reader will gain an appreciation of the paper’s enormous stature in the field and why so much excitement has always surrounded it. So how does “overshooting” work? Now, I would be the last to claim that the generalized failure of structural exchange rate models, as found in the post Meese-Rogoff literature, should not be taken seriously, even though there has been some progress here in the recent literature towards resolving these puzzles. Obstfeld and Stockman discuss these models in their Handbook of International Economics chapter, and I will leave the reader to look there for further details and references.

PhelpsJournal of Political Econom y, 84, February But Dornbusch’s work is a perfect illustration of why the search for abstract beauty can sometimes yield a large practical payoff. But the elegance and clarity of Dornbusch’s model, and its obvious and immediate policy relevance, puts his paper in a separate class from the other international macroeconomics papers of its time.

Equation 2 is a simple variant of the Goldfeld money demand function. Of course, the two effects interact, but I leave this discussion to another day.

Overshooting model – Wikipedia

Frankel, Jeffrey,”On the Mark: Formally testing the Dornbusch model is easier said than done. You could see in the students’ faces that something special was happening.


The new view can be found in many places, but certainly in the closed economy work of authors such as Rotemberg and WoodfordWoodfordand of course in New Open Economy Macroeconomics.

But if it is not at this intersection, then it must lie on the line marked by arrows, as any other starting point will lead down a path in which the exchange rate either explodes or collapses, even if the money supply remains constant. The general approach has been applied to a host of different problems, including the “Dutch disease,” the choice of exchange rate regime, commodity price volatility, and the analysis of disinflation in developing countries.

At the same time, however, they can be viewed as direct descendants.

Several recent attempts to reconcile exchange rate theory and data turn on generalizing this equation, though it remains to proven how fruitful this approach will be. The broad concept of overshooting has taken on a life far beyond the academic sphere.

News and World Report. Nevertheless, the general point that current account dynamics can have large medium term impacts on real exchange rates remains an important one empirically. According to the model, when a change in monetary policy occurs e.

Now, if we were to magnify these graphs, a bit more daylight would appear between the curves. It is a framework for thinking about international monetary policy, not simply a model for understanding exchange rates. Here, we will adopt the variant Dornbusch presented in an appendix to his paper, in which output is endogenous stkcky demand determined.

The main feature of the model is the Keynesian assumption that the price of domestic goods cannot adjust immediately to clear the goods market. Dognbusch or around the time of Dornbusch’s writing, Kouri and Calvo and Rodriguez were proposing a very different notion dotnbusch overshooting.


In recent months, both Federal Reserve Chairman Alan Greenspan June and Bank of France President Jean-Claude Trichet May have discussed overshooting in speeches, and one can find countless more references by other world financial leaders, not least sornbusch developing countries. As one can see, the exchange rate must overshoot its long-run equilibrium.

But the prrice and models in Mundell’s papers are now badly dated, and are not always easy to digest for today’s reader even if at the time they seemed a picture of clarity compared to the existing state of the art, Meade As a consequence, aggregate demand y d can temporarily deviate from its full-employment level. Mundell is a creative giant who was thinking about a single currency in Europe back when intergalactic trade seemed like a more realistic topic for research.

The Chicago-Minnesota School maintained that sticky prices were nonsense and continued to advance this view for at least another fifteen years.

Overshooting model

It is better suited than Dornbusch’s original formulation to dealing with more complex exogenous shocks processes. Journal of Political Economy. Third, a formal analysis brings out subtle details such as the assumption of no speculative asset price bubbles. The vertical equation is the real exchange rate adjustment equation 5.

Still a Useful Policy Tool A word about New Open Economy Macroeconomics, which Obstfeld surveyed last year; certainly this literature sricky come to dominate the academic literature on international macroeconomic policy.