Dornbusch Model
DORNBUSCH MODEL
Professor: Thomas Gries.
Course: International Finance &Exchange Rates. Paula de Cobos García. Winter Semester 2014/15.
1. Write down the Dornbusch Overshooting Model: central elements with the according equations.
A) INTRODUCTION. “In a very influential paper Dornbusch (1976) developed a model to explain Exchange rate overshooting, a phenomenon which occurs when, during the adjustment to new equilibrium, Exchange rates temporarily overshoot their long run values. This can explain what appears to be excessive volatility in Exchange rates. The novel feature of the model is the explicit treatment of differential speeds of adjustment in the goods and asset markets. Asset markets adjust quickly, almost instantaneously to shocks, while goods markets are sluggish, and adjustment is slow”.
The Dornbusch Model is a hybrid, it combines the short run features as the Mundell-Fleming model, which it not takes no account of expectations and the price level is fixed; and the long-run characteristics of the monetary model.
What Professor Rudiger Dornbush could observe during his exploration was that while product markets adjust only slow, financial markets appear to adjust far more rapidly-almost instantaneously, in fact.
The consequence of the real world is that financial markets have to over-adjust to perturbations, for compensating the stickiness of prices in goods markets. As a consequence of the delayed of the beginning of product prices, the interest rate, aggregate demand and the real Exchange rate return to their original values. Like in the monetary model, all the real magnitudes ends where they started, and the nominal Exchange rate at a new long-term level that reflects the proportionate change in the money supply.
One characteristic of the overshooting model is that is likely to respond to a real perturbation.
Dornbusch model has some
Professor: Thomas Gries.
Course: International Finance &Exchange Rates. Paula de Cobos García. Winter Semester 2014/15.
1. Write down the Dornbusch Overshooting Model: central elements with the according equations.
A) INTRODUCTION. “In a very influential paper Dornbusch (1976) developed a model to explain Exchange rate overshooting, a phenomenon which occurs when, during the adjustment to new equilibrium, Exchange rates temporarily overshoot their long run values. This can explain what appears to be excessive volatility in Exchange rates. The novel feature of the model is the explicit treatment of differential speeds of adjustment in the goods and asset markets. Asset markets adjust quickly, almost instantaneously to shocks, while goods markets are sluggish, and adjustment is slow”.
The Dornbusch Model is a hybrid, it combines the short run features as the Mundell-Fleming model, which it not takes no account of expectations and the price level is fixed; and the long-run characteristics of the monetary model.
What Professor Rudiger Dornbush could observe during his exploration was that while product markets adjust only slow, financial markets appear to adjust far more rapidly-almost instantaneously, in fact.
The consequence of the real world is that financial markets have to over-adjust to perturbations, for compensating the stickiness of prices in goods markets. As a consequence of the delayed of the beginning of product prices, the interest rate, aggregate demand and the real Exchange rate return to their original values. Like in the monetary model, all the real magnitudes ends where they started, and the nominal Exchange rate at a new long-term level that reflects the proportionate change in the money supply.
One characteristic of the overshooting model is that is likely to respond to a real perturbation.
Dornbusch model has some