Talk:Overshooting model/Archive 1

Archive 1. Back to talk page. changed it around a bit, still another small bit to complete

eamo

I've added the key references for Dornbusch's "overshooting model". The text about it now needs some work. (For one thing, the parentheses in the formula don't balance.)

The key insight from Dornbusch is that lags in some parts of the economy can induce additional volatility in others to compensate. Dornbusch wrote this back when many economists were still claiming that ideal markets should reach equilibrium and stay there. Volatility was thought to be a consequence of imperfect information or market obstacles. But it's not; volatility is more fundamental than that.

It's a neat result. Read Rogoff's paper, now linked on the article page.

Someone with a strong economics background needs to review this. --John Nagle 04:58, 13 April 2006 (UTC)[reply]

I'm currently trying to clean up, expand and cite the article. I think between the citations added and the Romer citation I just added, the citation notification can be removed. Thoughts?

I'm not convinced that the explaination given is correct. But I don't feel qualified to edit it myself. It really does need someone with a strong economics background. --John Nagle 04:27, 22 April 2006 (UTC)[reply]

Oops thought I signed. Well, I'm a PhD candidate at George Mason University so I'd like to think I have a strong economics background, at least strong enough to edit the article. (By the way, how does one make graphs for Wikipedia? There's a great graph that goes with this model but I have no idea how to make a computer one...what's the program everyone's using?) David Youngberg 16:20, 23 April 2006 (UTC)[reply]

OpenOffice Draw is popular for graphs.

I'm more of a control theory person. This result is well known in control theory; a feedback system with two different lags will usually generate some oscillation and overshoot. Economics has a historical tendency to assume that feedback leads to stability, which isn't really the case. This paper is significant because it finally made the economics community accept that instability is inherent, not a product of non-ideal markets. The article somehow should capture those ideas. (Now finance people do get this; you can take courses on how to use Laplace transforms to stabilize your cash flow. [1]). --John Nagle 16:52, 23 April 2006 (UTC)[reply]

Well, the role of stability is something completely different but this model doesn't predict "instability." Few models do (because of simplifying assumptions, mostly). All the model says is there will be overvaluing at first but will settle down as sticky prices adjust. David Youngberg 03:52, 26 April 2006 (UTC)[reply]

2 notes

Well, three, the first one being that the article is still a mess. Other than that

1. The word explanation of the model does not explain the role that expectations play in generating the overshooting. Relatedly, it doesn't say anything about purchasing power parity (PPP) or the uncovered interest parity condition (UIP). In fact, probably the easiest way to present the model is to say that in the short run, with sticky prices, it is the financial markets which determine exchange rate through the UPI (R1=R2+%dE(expected)). But in the long run it's the goods markets through price adjustments and the PPP (E=P1/P2) (and of course also financial markets). Since in the short run agents in the model are aware what's going to happen in the long run, they revise their expectations accordingly. And since expectations affect the spot rate this creates "additional" effects in the short run - the overshooting. Of course a bit of explanation what PPP, UIP etc are is necessary.

2. It's not quite correct to say that "the model explains fluctuations in absence of market imperfections". The model relies on sticky prices in the short run which generally are seen as some kind of market imperfection (though perhaps due to a "real" rigidity). On the other hand, unlike assumptions about irrationality, incomplete markets, imperfect information etc., at the time the model was written down, sticky prices were a standard assumption in macroeconomic work. So it's more like the model uses the simplest and most widely accepted form of market imperfection to generate the result.radek (talk) 21:55, 11 January 2010 (UTC)[reply]

Question How come initial equilibrium r on the upper left graph is not the same as equilibrium r on the upper right graph (initial IS-LM curves intercept)? Lkzavr (talk) 14:11, 10 February 2011 (UTC)[reply]