Exchange rate overshooting suggests that an unexpected increase in the domestic money supply by 10 percent will cause the short-run exchange rate value of the domestic currency to:
A)depreciate by more than 10 percent.
B)depreciate by less than 10 percent.
C)appreciate by more than 10 percent.
D)appreciate by less than 10 percent.

Question

Quizplus · Accepted Answer

Exchange rate overshooting refers to the tendency of the exchange rate to initially move more than proportionately in response to a shock, such as an unexpected increase in the domestic money supply. In this case, the domestic currency will depreciate by more than 10 percent in the short-run, as the market adjusts to the new equilibrium. This is because the initial response will be to overshoot the long-run equilibrium exchange rate, before eventually settling down around the new long-run equilibrium.

Exchange Rate Overshooting Suggests That an Unexpected Increase in the Domestic