AS-AD revisited: overshooting adjustment dynamics under naive expectations

Publication: Scientific journalJournal articlepeer-review

Abstract

We analyse the adjustment dynamics from a short-term to a medium-term equilibrium in a standard
AS-AD model à la Blanchard (2006, Macroeconomics, 4th edn, Prentice-Hall, Upper Saddle River, NJ)
for an open economy with fixed and flexible exchange rates. An explicit analysis suggests the local
stability of the medium-term equilibrium. However, an overshooting adjustment dynamics is possible
for the exchange rate, a result that directly relates to the famous Dornbusch (1976, Journal of Political
Economy, 84, pp. 1161–1176) analysis. In contrast to the latter, in the Blanchard framework it is
obtained without assuming rational expectations and without relying upon saddle-path stability.
Original languageEnglish
Pages (from-to)574 - 593
JournalMetroeconomica
Volume59
Issue number4
Publication statusPublished - 1 Oct 2008

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