Exchange Rate Flexibility, Volatility, and the Patterns of Domestic and Foreign Direct Investment

Joshua Aizenman

NBER Working Paper No. 3953 (Also Reprint No. r1787)
Issued in January 1992
NBER Program(s):International Trade and Investment, , International Finance and Macroeconomics

The goal of this paper is to investigate the factors determining the impact of exchange rate regimes on the behavior of domestic investment and foreign direct investment (FDI), and the correlation between exchange rate volatility and investment. We assume that producers may diversify internationally in order to increase the flexibility of production: being a multinational enables producers to reallocate employment and production towards the more efficient or the cheaper plant. We characterize the possible equilibria in a macro model that allows for the presence of a short-run Phillips curve, under a fixed and a flexible exchange rate regime. It is shown that a fixed exchange rate regime is more conducive to FDI relative to a flexible exchange rate, and this conclusion applies for both real and nominal shocks. The correlation between investment and exchange rate volatility under a flexible exchange rate is shown to depend on the nature of the shocks. If the dominant shocks are nominal, we will observe a negative correlation, whereas if the dominant shocks are real, we will observe a positive correlation between exchange rate volatility and the level of investment.

download in pdf format
   (306 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w3953

Published: "Exchange Rate Flexibility, Volatility, and Domestic and Foreign Direct Investment," from International Monetary Fund Staff Papers, Vol. 39, No. 4, pp . 890-922 (December 1992).

Users who downloaded this paper also downloaded* these:
Goldberg and Kolstad w4815 Foreign Direct Investment, Exchange Rate Variability and Demand Uncertainty
Froot and Stein w2914 Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach
Goldberg and Klein w6344 Foreign Direct Investment, Trade and Real Exchange Rate Linkages in Developing Countries.
Klein and Rosengren w4192 The Real Exchange Rate and Foreign Direct Investment in the United States: Relative Wealth vs. Relative Wage Effects
Aizenman w3767 Foreign Direct Investment, Productive Capacity and Exchange Rate Regimes
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us