The Financial Crisis As An Overshooting Phenomenon

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Executive Summary

Inspired by Dornbusch's model of exchange rate overshooting the authors develop a theory of stock market behaviour. The idea is that stock market prices overshoot and undershoot their long-run equilibrium values which are determined by the development in the real economy. The overshooting is fuelled primarily by a loose monetary policy. The simple macro model consists of three markets - the money market, the stock market and the goods market - interacting with different speeds of adjustment. The goods market slowly adjusts relative to the money and the asset market.

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