Exchange rate overshooting occurs in response to shocks from "summary" of International Money and Finance by Michael Melvin
When shocks hit an economy, exchange rates tend to overshoot. This phenomenon can be explained by the adjustment process that exchange rates go through in response to unexpected events. Shocks can come in many forms, such as changes in interest rates, inflation rates, or political events. Exchange rates are influenced by a variety of factors, including interest rate differentials, trade balances, and overall economic conditions. When a shock occurs, these factors are suddenly disrupted, causing exchange rates to move in a direction that may seem excessive at first glance. This overshooting is a natural response to the uncertainty and volatility created by the shock. The overshooting of exchange rates can have significant ...
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