Which of the following is a feature of the 'Dornbusch Overshooting' model?
A. Exchange rates always adjust gradually
B. Exchange rates may overshoot their long-run values in response to monetary shocks because of sticky prices
C. Only real shocks matter
D. Prices are fully flexible and exchange rates never overshoot
Answer: Option B
Solution (By JKSSB Mock Tests)
In Dornbusch’s overshooting model, sticky goods prices cause the exchange rate to jump more than proportionally to a monetary shock in the short run so that uncovered interest parity can hold.
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