sticky price theory aniket
TRANSCRIPT
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Presented By: Aniket Lakhe
PRESENTATION ON DORNBUSCHSTICKY PRICE THEORY
( UNIT II FOREIGN EXCHANGE
MANAGEMENT)
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Rdiger "Rudi"
Dornbusch (June 8,1942 July 25, 2002)
was a Germaneconomist who worked
for most of his career inthe United States.
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DORNBUSCH STICKY PRICE THEORY
The sticky price theory makes a more
detailed study of interest rates differential.
The sticky price model generates an upwardsloping short run aggregate supply curve.
This is because firms are rigid in changing
prices in response to changes in the
economy.
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Dornbusch developed this model back when many
economists held the view that ideal markets should
reach equilibrium and stay there. Volatility in a
market, from this perspective, could only be aconsequence of imperfect information or
adjustment obstacles in that market.
Dornbusch argued that volatility is in fact a far
more fundamental property than that.
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His model assumes that, while the prices of goods
are sticky (slow to adjust), the exchange rate
adjusts instantaneously to any change in current
financial market conditions. Yet the stickiness ofgoods prices causes evolution over time in the
goods market, and due to market linkages this
leads to evolution over time in the foreign exchange
market equilibrium. This results in variability in theexchange rate even after a shock to that market has
gone away hence the exchange rate volatility.
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The increase in money supply in the market
( due to changes in real interest rate
differential) leads to depreciation in the value
of the domestic currency.
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ASSUMPTIONS OF THIS THEORY
The money supply is endogenous.
i.e. it is positively related to the market interest
rates. PPP (purchase power parity)theory applies in
the long run.
So the expected inflation differential changes havea role to play in the determination of interest rates.
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TWO SECTION OF
STICKY PRICE THEORY
Study of interest rates differential.
a) Increase in Money Supply --------- Depreciationof Domestic Currency.
b) Rise in Interest Rates ------- Increase in MoneySupply (Loanable Funds)-------Depreciation ofDomestic Currency.
c) Rise in Interest Rates------- Greater Inflows ofCapital-------- Appreciation of DomesticCurrency.
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Study of inflation rates differential.
a) Increase in Money Supply------ Price Rise ----------
Lower Interest Rate-------- Lower Inflow of Capital ------ Depreciation of Domestic Currency.
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CONCLUSION
The Dornbusch sticky price model - also calledovershooting model - represents a major contribution toexchange rate theory in the sense that departures frompurchasing power parity and volatile currency levels can be
explained rationally.
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