Gradual Output Adjustment and Expansionary Monetary Policy

In: Journal of economic studies, Band 19, Heft 1

Abstract

Examines the effects of a monetary expansion on certain key
macroeconomic variables, in particular the nominal exchange rate,
competitiveness, and domestic output and employment, using a modified
version of the Dornbusch (Journal of Political Economy, 1976)
model. Dornbusch′s original analysis of the implications of sticky
prices was conducted on the basis of two alternative assumptions
concerning the supply side of the economy, a fixed (full‐employment)
level of output and (in his Appendix) continuous goods market clearing,
maintained by instantaneous output adjustment. Neither of these
assumptions appears particularly satisfactory and the model presented
here attempts to address the issue by assuming output to be
instantaneously fixed, but to respond gradually to excess demand or
supply in the goods market. The structure of the resulting model is such
as to imply a third‐order dynamic adjustment process which is solved
explicitly. Two principal conclusions follow from the analysis. First,
despite the fact that the monetary expansion inevitably reduces the
domestic interest rate, nominal exchange rate overshooting need not
result. Second, the dynamics of adjustment are considerably more
complicated than in the original Dornbusch model and may, in fact, be
cyclical in nature.