Exchange rate theory analysis: overshoot model and economic data interpretation.

Exchange rate overshooting theory

The theory was developed by the American economist Rudiger Dornbusch in the 1970s. It is also known as the Sticky-Price Monetary Approach for determining exchange rates. An overshoot usually refers to a variable that, in response to a particular perturbation, moves by more in the short term than the long-run stable equilibrium value, which is then corrected by adjustments in the opposite direction. An overshoot of exchange rates presupposes that commodity prices are sticky. The so-called sticky price is that the price of a commodity remains static in the short term, but the price level gradually changes over time until a new long-term equilibrium value is reached.

Analysis conclusion:

(1) The equilibrium exchange rate is determined jointly by the commodity market and the currency market.

(2) When the money market is unbalanced, interest rates can adjust rapidly, but due to the stickiness of commodity market prices, short-term interest rates overshoot, exceeding the long-term equilibrium level, which in turn triggers an overshoot of the exchange rate.

A striking feature of Dornbusch's exchange rate overshoot model is that it fuses Keynesian short-term analysis with monetarist long-term analysis; it uses the concept of price stickiness to make it more realistic. At the same time, the model has clear policy implications: it shows that the long-term end result of the effect of monetary expansion or contraction is to cause prices and exchange rates to rise or fall in the same proportion. But in the short run, monetary expansion or contraction does have real effects on interest rates, terms of trade and aggregate demand. When governments use expansionary or contractionary monetary policy to adjust the macro economy, they need to be vigilant about whether the exchange rate will overshoot and overshoot, so as to avoid unnecessary fluctuations in the economy.

Dornbusch's exchange rate overshoot model is the basic model for macroscopic analysis of open economy in international finance; it first involves the dynamic adjustment of exchange rate, creates a precedent for analyzing exchange rate adjustment from a dynamic perspective, and thus creates an important branch of exchange rate theory - Exchange Rate Dynamics.

2 Data interpretation

Modern financial theory attaches great importance to the role of expectations, and investors often compare the actual value of economic data with the expected value. When there is a large difference between the expected value and the actual value, it is easy to cause fluctuations in investor sentiment, and the current development of computer technology may lead to a large number of stop-loss orders being triggered, which can cause violent fluctuations in exchange rates. According to Soros' reflexivity theory, knowledge is a function of change in cognition, and behavior is a function of change in behavior. Price changes themselves can prompt value to develop in a direction that deviates from equilibrium. The non-farm payrolls report released on the first Friday of each month, because it is an important economic data released earlier, and the actual value is often significantly different from the expected value, can cause violent fluctuations in financial marekts. For traders who pay attention to the dynamics of foreign exchange, such as throughPepperstoneFor investors operating on such platforms, understanding these data fluctuations is particularly important.

The US non-farm payrolls report

The employment report contains information related to employment and is derived from two separate surveys, namely the business survey and the household survey.

Among them, the business survey provides employment in the non-agricultural sector, with an index of average hours worked and total hours worked; the household survey provides data on the labor force, household employment, and unemployment rate. Non-farm employment measures the number of people with income in all non-agricultural industries, such as manufacturing and services.

The monthly non-farm payrolls report in the United States is often hailed asforeign exchange marketThe "crown jewel" of economic indicators that reflect sensitive information, it is one of the most closely watched monthly economic indicators in the market, and investors can often obtain a lot of market-sensitive information from it.

Currency markets place particular emphasis on seasonally adjusted monthly changes in US payrolls. Strong non-farm payrolls suggest a healthy economy and could signal higher interest rates. Potentially higher rates would encourage currency markets to push the dollar up more, and vice versa.

Therefore, when the US non-farm payrolls data performs well or exceeds expectations, it usually boosts the dollar strongly; when the data is weak or does not meet expectations, it often causes the dollar to decline.