IGNOU BECC 106 2025 2026 - State the reasons behind exchange rate overshooting.

Question

State the reasons behind exchange rate overshooting.

02 Mar 2026

Answer :

Word Count : 511

Exchange rate overshooting is a phenomenon in international macroeconomics where the nominal exchange rate initially reacts more than proportionately to a change in monetary policy or economic fundamentals before gradually moving back toward its long-run equilibrium. The primary theoretical explanation for exchange rate overshooting comes from the Dornbusch (1976) model, which integrates sticky prices in goods markets with flexible exchange rates in asset markets. The reasons behind exchange rate overshooting can be understood through several interrelated mechanisms in intermediate macroeconomics. One major reason is the difference in the speed of adjustment between financial markets and goods markets. Exchange rates are highly flexible and can adjust almost instantaneously

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