AS-AD REVISITED: OVERSHOOTING ADJUSTMENT DYNAMICS UNDER NAÏVE EXPECTATIONS

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. Copyright © 2008 The Authors. Journal compilation © 2008 Blackwell Publishing Ltd.