Expectations and Exchange Rate Dynamics

1976/12/01 by Rudiger Dornbusch, Rüdiger Dornbusch · 4,715 citations
Economics, Econometrics and Finance · #Asset (computer security) #Capital (architecture) #Capital formation #Complex Systems and Time Series Analysis #Depreciation (economics) #Differential (mechanical device) #Econometrics #Economic theories and models #Economics #Exchange rate #Interest rate #Microeconomics #Monetary Policy and Economic Impact #Monetary economics #Path (computing) #Physics

paper · doi:10.1086/260506

published in Journal of Political Economy 84(6), 1161-1176 (University of Chicago Press)

openalex publication_date 1976/12/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/04

Abstract

The paper develops a theory of exchange rate movements under perfect capital mobility, a slow adjustment of goods markets relative to asset markets, and consistent expectations. The perfect foresight path is derived and it is shown that along that along that path a monetary expansion causes the exchange rate to depreciate. An initial overshooting of exchange rates is shown to derive from differential adjustment speed of markets. The magnitude and persistence of the overshooting is developed in terms of the structural parameters of the model. To the extent that output responds to a monetary expansion in the short run, this acts a a dampening effect on exchange depreciation and may, in fact, lead to an increase in interest rates.

Cited by

• Banking on currency forecasts: How predictable is change in money?
• Out-of-sample exchange rate predictability with Taylor rule fundamentals
• Price Index Convergence Among United States Cities*
• Cointegration Tests of the Monetary Exchange Rate Model for Three High-Inflation Economies
• Foreign Safe Asset Demand and the Dollar Exchange Rate
• Proof-of-Stake Dynamics: The Elusive Price Anchor and Endogenous Volatility Harvesting
• How to grow an invoicing currency: Micro evidence from Argentina
• A roller coaster ride: an empirical investigation of the main drivers of the international wheat price
• Did the Plaza Accord cause Japan's real estate bubble?
• Monetary policy credibility, avoiding dark corners, and risk management: a response to Ben Bernanke's review of monetary policy-making at the Bank of England
• The straw that breaks the camel's back: inferential expectations and sudden belief changes
• Model instability in predictive exchange rate regressions
• FX-constrained growth: Fundamentalists, chartists and the dynamic trade-multiplier
• Demand for safe assets and spillovers from the global dollar cycle
• Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model
• Convergence Across States and Regions
• Mean and volatility dynamics of Indian rupee/US dollar exchange rate series: an empirical investigation
• Chaos in Foreign Exchange Markets: A Sceptical View
• IS-LM-BP: An Inquest
• Pre-Brexit
• Statistical learning and exchange rate forecasting
• What Do We Know about Macroeconomics that Fisher and Wicksell Did Not?
• Estimating long-run equilibrium real exchange rates: short-lived shocks with long-lived impacts on Pakistan. [europepmc]
• Bond market opening, monetary policy, and systemic financial risks - An empirical study based on the TVP-SV-VAR model. [europepmc]
• Foreign and Domestic Uncertainty Shocks in Four Open Economies [europepmc]
• The role of domestic and foreign economic uncertainties in determining the foreign exchange rates: an extended monetary approach [europepmc]
• Is the floating exchange rate a shock absorber in Albania? Evidence from SVAR models [europepmc]

Related

• Exchange rate-based stabilization. Pleasant monetary dynamics?
• Trade Dynamics with Heterogeneous Fluctuations
• Exchange rate dynamics and monetary policy
• The Macroeconomic Consequences of Exchange Rate Depreciations
• Fear of appreciation and current account adjustment