what is overshooting 
in economics overshooting also known as the exchange rate overshooting hypothesis is a way to think about and explain high levels of volatility in currency exchange rates using the concept of price stickiness understanding overshootingovershooting was introduced to the world by r diger dornbusch a renowned german economist focusing on international economics including monetary policy macroeconomic development growth and international trade dornbusch first introduced the model now widely known as the dornbusch overshooting model in the famous paper expectations and exchange rate dynamics which was published in 1976 in the journal of political economy 1before dornbusch economists generally believed that markets should ideally arrive at equilibrium and stay there some economists had argued that volatility was purely the result of speculators and inefficiencies in the foreign exchange market such as asymmetric information or adjustment obstacles dornbusch rejected this view instead he argued that volatility was more fundamental to the market than this much closer to inherent in the market than to being simply and exclusively the result of inefficiencies more basically dornbusch was arguing that in the short run equilibrium is reached in the financial markets and in the long run the price of goods responds to these changes in the financial markets price stickiness refers to the tendency of some prices to move slowly in response to changes in the market the overshoot model states that exchange rates react strongly to monetary policy while goods prices tend to be sticky the overshooting model argues that the foreign exchange rate will temporarily overreact to changes in monetary policy to compensate for sticky prices of goods in the economy this means that in the short run the equilibrium level will be reached through shifts in financial market prices rather than through shifts in the prices of goods themselves gradually as the prices of goods unstick and adjust to the reality of these financial market prices the financial market including the foreign exchange market also adjusts to this financial reality so initially foreign exchange markets overreact to changes in monetary policy which creates equilibrium in the short term then as the prices of goods gradually respond to these financial market prices the foreign exchange markets temper their reaction and create long term equilibrium thus there will be more volatility in the exchange rate due to overshooting and subsequent corrections than would otherwise be expected special considerationsalthough dornbusch s model was compelling initially it was also regarded as somewhat radical due to its assumption of sticky prices today sticky prices are accepted as fitting with empirical economic observations and dornbusch s overshooting model is widely regarded as the forerunner to modern international economics in fact some have said it marks the birth of modern international macroeconomics 2the overshooting model is considered especially significant because it explained exchange rate volatility during a time when the world was moving from fixed to floating rate exchanges kenneth rogoff during his stint as economic counselor and director of the research department at the international monetary fund imf said dornbusch s paper imposed rational expectations on private actors about exchange rates rational expectations is a way of imposing overall consistency on one s theoretical analysis rogoff wrote on the paper s 25th anniversary 3