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EXCHANGE RATE OVERSHOOTING AND PATH-DEPENDENCE IN INTERNATIONAL TRADE

Published online by Cambridge University Press:  20 March 2007

TROND-ARNE BORGERSEN  and
MATTHIAS GÖCKE
TROND-ARNE BORGERSEN
Affiliation:
Halden University College and The Financial Supervisory Authority of Norway
MATTHIAS GÖCKE
Affiliation:
University of Giessen
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Abstract

This paper integrates a traditional Dornbusch overshooting model with a macro-economic model of hysteresis in foreign trade. We apply an approach which allows an aggregation of heterogeneous agents and which results in a continuous macroeconomic hysteresis-loop. In our model, short-run exchange rate overshooting generates a persistent current account effect, which feeds back into the exchange rate process and ultimately results in changes of the long-run equilibrium exchange rate. Monetary shocks can lead to hysteresis in both foreign trade and exchange rate processes, invalidating the long-run neutrality of money hypothesis and the purchasing power parity assumption of the conventional overshooting model.

Keywords

Exchange RatesDornbusch ModelHysteresisForeign TradePPP
Type
ARTICLES
Information
Macroeconomic Dynamics , Volume 11 , Issue 3 , June 2007 , pp. 295 - 317
Copyright
© 2007 Cambridge University Press

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