Order Description

Consider the asset approach of exchange rate determination, in which the short-run price adjustment of the goods market is sluggish. Answer the following questions:
a) Utilise the graphs (and general equations) for the money and FX markets equilibrium
conditions, explain how the exchange rate overshooting phenomenon may occur
[40 marks]
b) Following the parameterised model à la Dornbusch (1976), assume that • the goods market equilibrium conditions are governed by
= ? + + ( ? )
? = ( ? ? )
where d, y, r, e, p are the variables for demand, output(supply), interest rate, exchange rate and price in log form; ? represents the long-run (assuming constant)
level of variable x. ? represents ; u can be considered as autonomous spending; ,
, are parameters (demand elasticities) and can be thought as the price
adjustment speed parameter in response to excess demand • the money market equilibrium conditions are governed by
? = ? +
where m is the (log) money stock variable; and are parameters (money demand
elasticities)
• the FX equilibrium conditions are governed by
= ? + ( ? ? )
where r* is the interest rate in the world capital market (assuming constant); can be
thought as the parameter for the expected adjustment speed of exchange rate Solve the model and Show that the cases of over-/under-shooting depends on
1? .0 1?
Explain and comment on your derivations and results.
c) Utilise literature and illustrate whether the exchange rate overshooting model is supported
by empirical findings and is useful for policy makings.
[20 marks]
Notes: In addition to the relevant discussions from the lectures, seminars and the reference textbooks, the following reading list may also be helpful. ). The following list contains hyperlinks for
access (simply by clicking). You may also access these papers via the links from Blackboard or iFind searching. Self-exploration and research for other good quality of literatures are also
recommended.
[40 marks]
5

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