Chartered Financial Analyst (CFA) Practice Exam Level 2

Which of the following is NOT a characteristic of the Dornbusch Overshooting Model?

1. Focus on short-run dynamics

2. Emphasis on sticky prices

3. Long-term interest rate predictions

4. Reaction to fiscal policy changes

The correct answer is: Long-term interest rate predictions

The Dornbusch Overshooting Model is primarily concerned with the behavior of exchange rates in response to changes in economic fundamentals, especially in the context of short-run dynamics and the impact of sticky prices. The model demonstrates how short-run fluctuations in exchange rates can overshoot their long-run equilibrium values due to discrepancies in price adjustment and market expectations. One of the key characteristics of this model is its focus on short-run dynamics, as it effectively captures how immediate responses to monetary policy, interest rates, and other economic factors lead to overshooting in exchange rates before they adjust to their long-run equilibrium levels. This underscores the idea that in the short term, prices do not adjust fully, which is also a critical feature of the model—this is where the concept of sticky prices comes into play. While the model can discuss how fiscal policy changes might influence currency values in the short term, it does not specifically aim to make long-term interest rate predictions. Instead, its primary focus is limited to short-term exchange rate reactions. Hence, the statement about long-term interest rate predictions does not align with the model's principal characteristics, making it the correct choice for the question regarding what is NOT characteristic of the Dornbusch Overshooting Model.