Title:
THE OVERSHOOTING MODEL OF EXCHANGE RATE DETERMINATION

Authors:
Dr. Ioannis N. Kallianiotis, USA

Abstract:

The purpose of this work is to test the exchange rate dynamics by looking at the speed of adjustment of prices with the use firstly, of a long-run monetary path and a short-run overshooting model and secondly, an Autoregressive Distributed Lag (ARDL) model. In these overshooting models, we assume price stickiness (gradual adjustment). If the prices are adjusted instantaneously, we will have the monetarist view; otherwise, the short-run overshooting one, due to slow adjustment of prices and consequently, it affects all the other variables and slowly the exchange rate. Thus, we outline, here, an approach of testing the dynamic models of exchange rate determination and expending the monetary model by using the ARDL process. This approach is based upon the view that it is difficult to measure directly the process by which market participants revise their expectations about current and future money supplies; except lately, where the Fed has made the forward guidance (zero interest rate) explicit. Further, it is possible to make indirect inferences about these expectations through a time series analysis of related financial and real prices. In addition, unit root and cointegration tests are taking place for testing the stationarity of the variables. Empirical tests of the above exchange rate dynamics are used for four different exchange rates ($/€, $/£, C$/$, and ¥/$). Theoretical discussion and empirical evidence have emphasized the impact of gradual adjustment and “overshooting” that it is taking place for some less market oriented countries, as Canada, the C$/$ and partially Japan, the ¥/$. For the $/€ and the $/£ exchange rates the monetarist model is correct; no overshooting.