Exchange Rate Dynamics with Foreign Reserves : Revisiting the Dornbusch Overshooting Model

The purpose of this study is to shed light over the management of foreign reserves that have contradictory policy intentions and impacts; (1) to defend the domestic currency (2) to depreciate the domestic currency. With this Möbius's strip-like nature in mind, we extend the Dornbusch (1976) exchange rate overshooting model with the foreign reserves. Alongside with financial vulnerability, the presence of foreign reserves amplifies or alleviates monetary policy shocks on the exchange rate