Cognitive Scaffold

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MENTAL MODEL · M5769

Dornbusch Overshooting

Dornbusch Overshooting
BusinessHigh supportFinance
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Updated 2026-08-09

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INTRODUCTION

English translation pending.

CORE DEFINITION

Formulated by Rudiger Dornbusch, the model combines sticky goods prices with flexible asset prices to explain exchange rate volatility. Because financial markets adjust instantly while goods prices adjust slowly, a monetary change pushes the exchange rate past its eventual level, and it then converges back as prices catch up. The core claim is that overshooting is a rational response to differing adjustment speeds. The qualification is that the model assumes uncovered interest parity and price stickiness that hold only approximately.

SCAFFOLDING EFFECT

psychology

Reduce cognitive load

- Use Speed Contrast: Identify which part of a system adjusts instantly and which adjusts slowly. - Use Overshoot Expectation: Anticipate that the fast component will move past its final level. - Use Reversal Planning: Prepare for the partial retracement that follows once the slow component catches up.

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Anchor fast decisions

Asset prices adjust immediately to new information while goods prices and wages respond only over time. To satisfy the expected return condition in the interim, the exchange rate must move beyond the level that will prevail once prices have adjusted, since only then does the expected future movement offset the interest differential. As prices gradually catch up, the exchange rate drifts back toward its long-run value.

MINIMUM ACTION

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Source support: Explicit

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    en.wikipedia.orghttps://en.wikipedia.org/wiki/Overshooting_modelZH · Explicit
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