Examines the effects of a monetary expansion on certain keymacroeconomic variables, in particular the nominal exchange rate,competitiveness, and domestic output and employment, using a modifiedversion of the Dornbusch Journal of Political Economy, 1976model. Dornbuschs original analysis of the implications of stickyprices was conducted on the basis of two alternative assumptionsconcerning the supply side of the economy, a fixed fullemploymentlevel of output and in his Appendix continuous goods market clearing,maintained by instantaneous output adjustment. Neither of theseassumptions appears particularly satisfactory and the model presentedhere attempts to address the issue by assuming output to beinstantaneously fixed, but to respond gradually to excess demand orsupply in the goods market. The structure of the resulting model is suchas to imply a thirdorder dynamic adjustment process which is solvedexplicitly. Two principal conclusions follow from the analysis. First,despite the fact that the monetary expansion inevitably reduces thedomestic interest rate, nominal exchange rate overshooting need notresult. Second, the dynamics of adjustment are considerably morecomplicated than in the original Dornbusch model and may, in fact, becyclical in nature.
Journal of Economic Studies – Emerald Publishing
Published: Jan 1, 1992