(Answered) What is exchange rate overshooting? Describe the effect using the example of an unexpected increase…

➤ How does the exchange rate behave immediately and over time after an unexpected domestic money supply increase?
Immediately the nominal exchange rate depreciates more than the new long-run value, creating the overshoot. Over time, domestic prices rise, real money balances decline, and interest rates increase. Capital returns and the currency then appreciates from the overshot level, converging gradually to the new equilibrium consistent with adjusted price levels.