{ "title": "Dornbusch's Overshooting Model After Twenty-Five Years, The Mundell-Fleming Lecture by Kenneth Rogoff, Economic Counselor and Director of the IMF Research Department", "publication": "IMF News, November 29, 2001", "sourceUrl": "https://www.imf.org/en/news/articles/2015/09/28/04/53/sp112901", "canonical": "https://www.imf.org/en/news/articles/2015/09/28/04/53/sp112901", "overlayPath": "/en/news/articles/2015/09/28/04/53/sp112901/index.md", "summary": "Given at the Second Annual IMF Research Conference, Washington, D.C.", "publishDate": "2001-11-29", "sections": [ { "heading": "Introduction", "content": "- Lecture given at the Second Annual IMF Research Conference, Washington, D.C., November 29-30, 2001; Mundell-Fleming Lecture delivered November 30, 2001 (revised January 22, 2002).\n- Purpose: (1) convey why Dornbusch's \"Expectations and Exchange Rate Dynamics\" (Journal of Political Economy, 1976) has been so influential; (2) discuss empirical evidence for and against the model and sketch the model; (3) touch on competing notions of overshooting." }, { "heading": "Why Dornbusch (1976) Matters", "content": "- Characterized as \"elegant\" and \"path breaking\"; revived and reformed the Mundell-Fleming framework by incorporating sticky prices with rational expectations.\n- Practical relevance: remains a quick policy tool for assessing monetary policy effects on exchange rates; applied beyond exchange rates to issues such as \"Dutch disease,\" exchange rate regimes, commodity price volatility, and disinflation in developing countries.\n- Conceptual insight: highlights interaction of sluggish goods markets with fast-clearing asset markets — a core idea retained in modern international macroeconomics." }, { "heading": "Empirical Influence and Pedagogical Reach", "content": "- Citation and teaching measures (1976–2001):\n - 917 published articles citing Dornbusch (1976) in the social science citation index (major economics journals).\n - 42 separate articles in International Monetary Fund Staff Papers cite Dornbusch (1976).\n - Roughly 40 percent of the issues of Staff Papers published between 1977 and 2001 included at least one article citing the Dornbusch model.\n - Peak citation years 1984-86: article received over 50 citations per year.\n - Late 1990s: still receiving over 25 citations per year.\n- Popular and policy salience:\n - Economist magazine: 14 articles including \"overshooting\" and \"exchange rates\" during 1999-2000.\n - Financial Times: eleven references to overshooting during 2001.\n - Cited in speeches by prominent central bankers (examples in 2001: Alan Greenspan in June 2001; Jean-Claude Trichet in May 2001).\n- Teaching: Dornbusch (1976) appears on virtually every advanced international finance course reading list surveyed." }, { "heading": "The Basic Overshooting Mechanism (Model Intuition)", "content": "- Core relationships:\n - Uncovered interest parity: domestic nominal interest rate i equals foreign interest rate i plus expected rate of depreciation Et (et+1 - et); e is log of exchange rate (home currency price of foreign currency).\n - Money demand: real money balances depend on money supply m, price level p, and output y (logarithms), with interest sensitivity lowering money demand and output raising transactions demand.\n- Key assumptions driving overshooting:\n - Domestic price level p is sticky (does not move instantaneously).\n - Output y is exogenous in the short run (or adjusts sluggishly).\n - Money is neutral in the long run: a permanent rise in m leads to a proportionate rise in e and p.\n- Thought experiment:\n - A one-time unanticipated permanent increase in m with p fixed raises real balances m - p.\n - To equilibrate money market, domestic interest rate i must fall.\n - By uncovered interest parity, expected future appreciation is required; because long-run effect is proportional depreciation, initial nominal exchange rate depreciation must exceed the long-run depreciation — hence overshooting." }, { "heading": "Theory: Formal Structure and Dynamics", "content": "- Rational expectations introduced to international macroeconomics: expectations must be model-consistent.\n- Aggregate demand relates negatively to the real exchange rate; price adjustment follows a forward-looking sticky-price rule (Mussa-style).\n- Dynamic system reduces to two simultaneous difference equations for the real exchange rate and price adjustment, producing saddle-path stability under typical parameter values (< 1 in Rogoff's exposition).\n- Graphical solution: initial post-shock exchange rate lies at intersection of 45-degree line and saddle-path; initial nominal depreciation exceeds long-run depreciation (overshooting)." }, { "heading": "Empirics: Evidence For and Against Overshooting", "content": "- Broad empirical consensus: difficulty systematically explaining short-run exchange rate movements for major currencies (Meese and Rogoff, 1983; Rogoff, 2001).\n- Model performance:\n - Captures major turning points in monetary policy (examples cited: Volcker-era U.S. deflation, Thatcher-era U.K. deflation).\n - Less successful at explaining many other large exchange rate swings.\n- Frankel (1979) generalization: under assumptions where monetary shocks predominate, generalized Dornbusch predicts a positive correlation between the real exchange rate and the real interest differential (high real interest rates bid up the real exchange rate).\n- Forward vs. spot comovement:\n - Flood (1981) prediction: spot should move by more than forward in a one-time unanticipated money supply change; empirical series for yen/dollar and mark/dollar show movements in spot and forward series that are almost indistinguishable, with forward rate volatility slightly lower than spot volatility in sample — differences small.\n- Caveats and refinements:\n - Empirical testing requires handling endogenous money supply, interest rates, real shocks, and alternative shock processes.\n - Model may describe major monetary regime shifts but not all short-run volatility.\n - Modern versions: when output is endogenous or money demand depends on consumption, overshooting need not occur." }, { "heading": "Undershooting and Parameter Sensitivity", "content": "- Parameter regimes matter:\n - Rogoff presents case with parameter < 1 producing upward-sloping saddle-path and overshooting.\n - If parameter 1 (money demand sensitive to output and aggregate demand sensitive to real exchange rate), saddle-path can be downward sloping and the model can predict undershooting.\n- Modern models with money demand dependent on consumption make undershooting more plausible." }, { "heading": "Competing and Complementary Overshooting Mechanisms", "content": "- Alternative approaches contemporaneous with Dornbusch:\n - Kouri (1976) and Calvo and Rodriguez (1977): overshooting driven by slow adjustment of national wealth/current account dynamics rather than sticky prices.\n - These models emphasize wealth/current account channels and medium-term real exchange rate effects.\n- Integration:\n - Dornbusch-type monetary sticky-price mechanisms mainly drive short-run dynamics.\n - Kouri/Calvo-Rodriguez wealth/current-account mechanisms can be central to long-run real exchange rate changes.\n - Unified frameworks (e.g., Obstfeld and Rogoff, 1995) can incorporate both channels." }, { "heading": "Lasting Contributions and Policy Relevance", "content": "- Main legacies:\n - Revitalized Mundell-Fleming framework and sustained its policy relevance for decades.\n - First mainstream marriage of sticky prices with rational expectations in international finance.\n - A model of notable theoretical simplicity and pedagogical clarity that continues to inform policy thinking.\n- Policy takeaway:\n - Dornbusch (1976) remains a useful, intuitive benchmark for analyzing monetary policy impacts on exchange rates, especially around major regime shifts, while acknowledging empirical limitations and the need for richer modern specifications.\n\nLecture: \"Dornbusch's Overshooting Model After Twenty-Five Years,\" Kenneth Rogoff, Mundell-Fleming Lecture, Second Annual IMF Research Conference, November 30, 2001 (revised January 22, 2002).\n\n---\n\n Content in this bundle\n\n- 112901pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure1pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure2apdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure2bpdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure2cpdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure3apdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure3bpdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure4pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure5pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure6pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure7adpdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Figure7egpdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Table1pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n- Table2pdf (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\n References\n\n- Germany and the IMF\n- United Kingdom and the IMF\n- Japan and the IMF\n- United States and the IMF\n- Speeches\n- Kenneth S. Rogoff\n- Second Annual IMF Research Conference\n- PRESS CENTER\n- Maurice Obstfeld's superb inaugural Mundell-Fleming lecture from last year (IMF Staff Papers, Vol. 47, 2001)\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp112901" } ], "bullets": [ "[Markdown version](/en/news/articles/2015/09/28/04/53/sp112901/index.md)", "[Structured JSON version](/en/news/articles/2015/09/28/04/53/sp112901/index.json)", "[Bundle manifest](/en/news/articles/2015/09/28/04/53/sp112901/bundle-manifest.json)", "Published: November 29, 2001", "Lecture given at the Second Annual IMF Research Conference, Washington, D.C., November 29-30, 2001; Mundell-Fleming Lecture delivered November 30, 2001 (revised January 22, 2002).", "Purpose: (1) convey why Dornbusch's \"Expectations and Exchange Rate Dynamics\" (Journal of Political Economy, 1976) has been so influential; (2) discuss empirical evidence for and against the model and sketch the model; (3) touch on competing notions of overshooting.", "Characterized as \"elegant\" and \"path breaking\"; revived and reformed the Mundell-Fleming framework by incorporating sticky prices with rational expectations.", "Practical relevance: remains a quick policy tool for assessing monetary policy effects on exchange rates; applied beyond exchange rates to issues such as \"Dutch disease,\" exchange rate regimes, commodity price volatility, and disinflation in developing countries.", "Conceptual insight: highlights interaction of sluggish goods markets with fast-clearing asset markets — a core idea retained in modern international macroeconomics.", "Citation and teaching measures (1976–2001):", "Popular and policy salience:", "Teaching: Dornbusch (1976) appears on virtually every advanced international finance course reading list surveyed.", "Core relationships:", "Key assumptions driving overshooting:", "Thought experiment:", "Rational expectations introduced to international macroeconomics: expectations must be model-consistent.", "Aggregate demand relates negatively to the real exchange rate; price adjustment follows a forward-looking sticky-price rule (Mussa-style).", "Dynamic system reduces to two simultaneous difference equations for the real exchange rate and price adjustment, producing saddle-path stability under typical parameter values (< 1 in Rogoff's exposition).", "Graphical solution: initial post-shock exchange rate lies at intersection of 45-degree line and saddle-path; initial nominal depreciation exceeds long-run depreciation (overshooting).", "Broad empirical consensus: difficulty systematically explaining short-run exchange rate movements for major currencies (Meese and Rogoff, 1983; Rogoff, 2001).", "Model performance:", "Frankel (1979) generalization: under assumptions where monetary shocks predominate, generalized Dornbusch predicts a positive correlation between the real exchange rate and the real interest differential (high real interest rates bid up the real exchange rate).", "Forward vs. spot comovement:", "Caveats and refinements:", "Parameter regimes matter:", "Modern models with money demand dependent on consumption make undershooting more plausible.", "Alternative approaches contemporaneous with Dornbusch:", "Integration:", "Main legacies:", "Policy takeaway:", "[112901pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_112901pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure1pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure1pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure2apdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2apdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure2bpdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2bpdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure2cpdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2cpdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure3apdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3apdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure3bpdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3bpdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure4pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure4pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure5pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure5pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure6pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure6pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure7adpdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7adpdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Figure7egpdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7egpdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Table1pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table1pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Table2pdf (PDF)](/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table2pdf.pdf){rel=\"external\" type=\"application/pdf\"}", "[Germany and the IMF](http://www.imf.org/external/country/DEU/index.htm)", "[United Kingdom and the IMF](http://www.imf.org/external/country/GBR/index.htm)", "[Japan and the IMF](http://www.imf.org/external/country/JPN/index.htm)", "[United States and the IMF](http://www.imf.org/external/country/USA/index.htm)", "[Speeches](https://www.imf.org/en/news/searchnews)", "[Kenneth S. Rogoff](https://www.imf.org/external/np/bio/eng/kr.htm)", "[Second Annual IMF Research Conference](https://www.imf.org/external/pubs/ft/staffp/2001/00-00/arc.htm)", "[PRESS CENTER](http://presscenter.imf.org/)", "[Maurice Obstfeld's superb inaugural Mundell-Fleming lecture from last year (IMF Staff Papers, Vol. 47, 2001)](https://www.imf.org/External/Pubs/FT/staffp/2000/00-00/arc.htm)", "[https://www.imf.org/en/home](https://www.imf.org/en/home)" ], "related": [ { "title": "112901pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_112901pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_112901pdf.pdf", "mime": "application/pdf" } }, { "title": "Figure1pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure1pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure1pdf.pdf", "mime": "application/pdf" } }, { "title": "Figure2apdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2apdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2apdf.pdf", "mime": "application/pdf" } }, { "title": "Figure2bpdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2bpdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2bpdf.pdf", "mime": "application/pdf" } }, { "title": "Figure2cpdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2cpdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure2cpdf.pdf", "mime": "application/pdf" } }, { "title": "Figure3apdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3apdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3apdf.pdf", "mime": "application/pdf" } }, { "title": "Figure3bpdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3bpdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure3bpdf.pdf", "mime": "application/pdf" } }, { "title": "Figure4pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure4pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure4pdf.pdf", "mime": "application/pdf" } }, { "title": "Figure5pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure5pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure5pdf.pdf", "mime": "application/pdf" } }, { "title": "Figure6pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure6pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure6pdf.pdf", "mime": "application/pdf" } }, { "title": "Figure7adpdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7adpdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7adpdf.pdf", "mime": "application/pdf" } }, { "title": "Figure7egpdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7egpdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_figure7egpdf.pdf", "mime": "application/pdf" } }, { "title": "Table1pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table1pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table1pdf.pdf", "mime": "application/pdf" } }, { "title": "Table2pdf", "role": "document", "sourceUrl": "https://www.imf.org/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table2pdf.pdf", "binary": { "path": "/-/media/websites/imf/imported/external/np/speeches/2001/kr/_table2pdf.pdf", "mime": "application/pdf" } } ], "alternates": { "markdown": "/en/news/articles/2015/09/28/04/53/sp112901/index.md", "json": "/en/news/articles/2015/09/28/04/53/sp112901/index.json", "bundleManifest": "/en/news/articles/2015/09/28/04/53/sp112901/bundle-manifest.json" }, "generatedAtUtc": "2026-09-27T11:01:18.819Z" }