Question

         Explain the circumstances under which exchange rate overshooting occurs. Why does exchange rate overshooting occur only under these circumstances?

Answer 1

A relationship between sticky prices and volatile exchange rates is defined by the overshooting model.

Overshooting is an inappropriate short-run acceleration of exchange rates. This arises because of the difference in the rate of change across markets. To be precise, the price in the demand for commodities is sticky. Yet price fluctuations in capital markets are immediate.

The prices of commodities in a market do not respond to a shift in foreign exchange rates automatically. Rather, a domino effect that includes other players (Market) like Bond, Money, Derivatives and Financial attempts to transform to change the effects on the prices of commodities.

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