Exchange Rate Overshooting

Abstract

Thus far it has been assumed that the price of a country’s output, or the domestic price level, does not change in the short–run but will fully adjust in the long–run to its new equilibrium level. Whether this failure to adjust in the short–run is due to lack of information of producers about current changes in demand, or to costs of continually making immediate price adjustments in response to frequent and often temporary changes in demand, is of little concern – all that is necessary for validity of the analysis is that prices do not change immediately but do change eventually. Moreover, since the speed at which the relevant individuals learn about economic changes that have occurred will almost certainly vary from instance to instance, and the cost of making price changes will vary in accordance with the institutional setting and the particular industries involved, any model of dynamic adjustment paths will be dependent upon assumptions that are specific to the time and place.