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From Dornbusch to Murphy: Stylized Monetary Dynamics of a contemporary Macroeconometric Model

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Abstract

Dornbusch's 1976 overshooting exchange rate model (hereafter, DBM) has long been known to underpin several large macro models, including the Murphy Model (MM). But the dynamic adjustment paths of variables in MM differ markedly from those in DBM, even qualitatively. A leading case in point is the exchange rate which in MM undershoots its new long run-equilibrium value after the injection of a monetary shock, and then actually moves away from this equi-librium for a time before approaching it via a damped cyclical adjustment path (whereas the corresponding path in DBM is monotonic). This paper gives a simplified account of how this comes about. The emphasis is not so much on theoretical rigour but on providing a convincing practical demonstration. Using the simplest form of DBM as a starting point, it is shown how one can develop a miniature model exhibiting an MM-like response to a monetary shock. The key idea is that aggregate demand does not respond instantaneously (as in DBM) to shocks in the macroeconomic environment, but shows some degree of inertia. Nothing more is required to reconcile the qualitative dynamics of MM with DBM.

Suggested Citation

  • Alan A. Powell, 1998. "From Dornbusch to Murphy: Stylized Monetary Dynamics of a contemporary Macroeconometric Model," Centre of Policy Studies/IMPACT Centre Working Papers ip-69, Victoria University, Centre of Policy Studies/IMPACT Centre.
  • Handle: RePEc:cop:wpaper:ip-69
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    References listed on IDEAS

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    1. Murphy, C W, 1988. "Rational Expectations in Financial Markets and the Murphy Model," Australian Economic Papers, Wiley Blackwell, vol. 27(0), pages 61-88, Supplemen.
    2. John B. Taylor, 1995. "The Monetary Transmission Mechanism: An Empirical Framework," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 11-26, Fall.
    3. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    4. Gruen, D.W.R. & Gizycki, M.C., 1993. "Explaining Forward Discount Bias: Is It Anchoring?," Papers 164, Princeton, Woodrow Wilson School - Public and International Affairs.
    5. Murphy, C W, 1988. "An Overview of the Murphy Model," Australian Economic Papers, Wiley Blackwell, vol. 27(0), pages 175-199, Supplemen.
    6. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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    Cited by:

    1. Herbert, Ric D & Bell, Rod D, 2004. "Constrained macroeconomic policy development with a separate predictive model," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 64(3), pages 467-476.
    2. Ric D. Herbert and Rod D. Bell, 2001. "Constrained Optimal Control Under Limited Knowledge," Computing in Economics and Finance 2001 14, Society for Computational Economics.

    More about this item

    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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