Explain and critically assess, Dornbusch`s model of nominal exchange rate volatility.
Money demand consisting of money supply , price level and output How does "overshooting " work ? The essence over overshooting is captured by combining equations with assumptions . Of most importance , one must assume that the domestic price level does not move instantaneously in response to unanticipated monetary disturbances , but adjusts only slowly over time . The power and generality of the overshooting idea derives precisely from the fact that one can figure it out without going back through their old math textbooks and breaking out the latest and greatest scientific calculator . The only equations
How does "overshooting " work ? The essence over overshooting is captured by combining equations with assumptions . Of most importance , one must assume that the domestic price level does not move instantaneously in response to unanticipated monetary disturbances , but adjusts only slowly over time . The power and generality of the overshooting idea derives precisely from the fact that one can figure it out without going back through their old math textbooks and breaking out the latest and greatest scientific calculator . The only equations
needed are the above mentioned two , and therefore the result is going to obtain across a broad class of models that incorporate sticky prices
Dornbusch 's rationale comes as a result of what was considered as radical thinking during his day and time . At the time Rudi was working on his , the concept of sticky prices was under attack . Despite the religious conviction among macroeconomic theorists that prices could not be sticky , Dornbusch 's model remained the favorite with international macroeconomists
Formally testing the Dornbusch model is easier said than done . To take the model to the task , one must first do the following : figure out how to allow for more general types of monetary disturbances of the money supply and interest rates . However , the so-called empirical failure of the Dornbusch model does not mean that we have to reject it as a useful tool for policy analysis . Although the overshooting concept dutifully illustrates the inner workings of the model , the usefulness of the model goes well beyond the overshooting prediction . It is a generalized framework for thinking about international macroeconomic policy . Aside from that , the model does not necessarily predict overshooting under every circumstance . In newer models consumption typically appears in place of output in money demand equations...
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