The Two-Country Overshooting Model and Construction of Variables

Abstract

In this paper, a two-country version of the Dornbusch (1976) open macroeconomics model with a free-floating exchange rate will be estimated. The model stems from Buiter (1988, p. 122) and is not reported here. Buiter did not derive an estimable equation for his two-country model. To get an estimable equation it was proceeded as follows: Buiter (1988, p. 124) derived the following equation for the long-run equilibrium real exchange rate:

$$ \bar q = \frac{1}{\Lambda }[\sigma {u^*} - {\sigma ^*}u] + \frac{{{\sigma ^*} + \sigma {\beta ^*}}}{\Lambda }\bar y - \frac{{\sigma + \sigma {\beta ^*}}}{\Lambda }{\bar y^*}. $$

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