Rudiger Dornbusch

HOW many economists are worth travelling thousands of miles to see? Rudi Dornbusch was the pre-eminent example of this rarest of species. He was a distinguished economic theorist, and a revered teacher. He was also fascinated by practical questions of economic policy—surprisingly unusual in a top-drawer theorist—and never afraid to offer advice to any government facing economic difficulties that engaged his interest. Rarest of all, though, he was a pleasure to witness in action. If the amusing and provoking Mr Dornbusch was on the list of speakers or attendees (it made no difference which), a conference on the other side of the world would be worth going to regardless of all other considerations.

Mr Dornbusch always relished an intellectual contest. His teaching style, like his approach to conferences, was notoriously confrontational. Economists such as Paul Krugman, Jeffrey Sachs and Larry Summers—none of them retiring types—were among those he put through the mill as students; Kenneth Rogoff, another of that group, and now the chief economist at the International Monetary Fund, reckons that Mr Dornbusch's international finance course at the Massachusetts Institute of Technology is the answer to the question, “When did you last see these men humiliated in public?” But students and colleagues seemed to love being beaten up by Mr Dornbusch. It was no disgrace, after all: it happened to everybody. It was done with great charm, so you could not take offence. Above all, you got so much out of it. A few bruises were a small price to pay for the intellectual excitement Mr Dornbusch invariably aroused.

Always stirring

Mr Dornbusch was born in Krefeld, Germany, in 1942. He was a student at the University of Geneva, graduating in 1966. An adviser urged him to advance his academic prospects by studying in America, so he did his PhD at the University of Chicago. Later, he taught there and at the University of Rochester. He moved to MIT in 1975, where he remained a professor of economics for the rest of his life.

Almost immediately upon arrival in Cambridge, he wrote the paper, a masterpiece of economic theory, that moved him to the highest rank of the profession. “Expectations and Exchange Rate Dynamics”, more often known simply as “the overshooting paper”, was an effort to account for the puzzling, excessively volatile, behaviour of floating currencies.

Suppose, the article said, the supply of money goes up unexpectedly. In the long term, prices will rise and nothing will be any different in inflation-adjusted terms. In the short term, though, prices are slow to adjust, interest rates fall, and so does the currency. Question: why would anybody continue to hold government bonds in this economy, if the interest rate has fallen and the currency is depreciating? The bonds, with their new lower interest rate, would still be worth holding if investors expected the currency to appreciate by enough to offset the interest-rate disadvantage—but the currency is falling. So what happens? Mr Dornbusch answered that the initial fall in the currency will have to be, as it were, too big. The exchange rate must overshoot. The currency has to drop far below its new long-term value to make room for the subsequent appreciation that will persuade investors to hold the bonds.

The answer is obvious once you see it, but certainly wasn't before Mr Dornbusch spelt it out. Also, if the basic idea now seems simple, it is because economists have become accustomed to applying this equilibrium-through-overshooting logic to all kinds of other phenomena. The term “overshooting” has itself spread far beyond academic economics, and has entered, for instance, the standard vocabulary of financial-market commentary. Even though theory today has moved on from Mr Dornbusch's first model, with its various simplifying assumptions, current theories are in many ways descended from it. As a result, it is scarcely an exaggeration to say that Mr Dornbusch reinvented international macroeconomics.

An extraordinarily productive man, he continued to work hard at theory, as well as writing, with Stanley Fischer, “Macroeconomics”, one of the most highly regarded textbooks of its kind (still a standard text, and now in its eighth edition). By the late 1980s, though, the balance of his interests had shifted away from theory and towards policy work. His ideas poured forth in various forms and forums.

His flair for disputation never moderated. Mr Fischer says that he took as his maxim a statement of Keynes: “Words ought to be a little wild, for they are the assault of thoughts on the unthinking.” Thank heavens, Mr Dornbusch was indeed a little wild. In his later years, that made him, among other things, a first-rate popular writer on economics.

As a policy adviser, he worked in many countries (especially in Latin America) and on all manner of issues. He gave unfailingly trenchant advice to an array of developing-country ministers and officials, including many who had asked him to. As often as not, the ministers and central-bank governors who approached him were former students. They still wanted Mr Dornbusch, albeit at some small cost to their pride, to show them the way.