Exchange rate overshooting is a phenomenon in international macroeconomics where the nominal exchange rate initially responds more than proportionally to changes in monetary or economic fundamentals before gradually adjusting to its long-run equilibrium. The concept was first formally explained by Rudiger Dornbusch in his influential 1976 model, which combined sticky prices in the short run with perfectly flexible exchange rates under the assumption of rational expectations. Understanding the reasons behind exchange rate overshooting requires examining the interaction between monetary policy, asset markets, and price rigidities. One primary reason for exchange rate overshooting is the presence of nominal price rigidity in the goods market. In the short run, prices of domestic goods and services are slow to adjust due to menu costs, contracts, and institutional frictions. When the central bank changes the money supply, the immediate effect is felt in financial markets, particularly the foreign exchange market, where prices are highly flexible. Since goods prices do not adjust instantly, any change in monetary policy creates a temporary disequilibrium in asset markets, prompting the exchange rate to move sharply. Another crucial factor is the differential speed of adjustment between asset prices and goods prices. Exchange rates, being financial variables, adjust almost instantaneously in response to new information, interest rate differentials, and expectations of future monetary policy. In contrast, domestic price levels respond slowly. As a result,