Real Exchange Rates, Economic Complexity, and Investment

IMF Working Papers, May 10, 2018

Source details

The response of firm-level investment to real exchange rate movements varies depending on the production structure of the economy.
Firms in advanced economies and in emerging Asia increase investment when the domestic currency weakens, consistent with the traditional Mundell-Fleming model.
In other emerging market and developing economies, as well as some advanced economies with a low degree of structural economic complexity, corporate investment increases when the domestic currency strengthens.
The latter result is consistent with Diaz Alejandro (1963)—in economies where capital goods are mostly imported, a stronger real exchange rate reduces investment costs for domestic firms.

Exchange-rate-driven investment dynamics are heterogeneous across countries and depend on the degree of structural economic complexity and the import content of capital goods.
Policy conclusions drawn from standard Mundell-Fleming intuition may not apply uniformly: in economies with high import dependence for capital goods, currency appreciation can stimulate corporate investment by lowering investment costs.
Recognizing this heterogeneity is important for exchange rate policy design, investment forecasting, and macroeconomic stabilization strategies.

Study focuses on firm-level investment responses to real exchange rate movements across advanced economies, emerging Asia, other emerging market and developing economies, and some advanced economies with low structural economic complexity.

Source: IMF Working Paper No. 2018/107.

Real Exchange Rates, Economic Complexity, and Investment, WP/18/107, May 2018
- Real Exchange Rates, Economic Complexity, and Investment, WP/18/107, May 2018 (Markdown version)
- Real Exchange Rates, Economic Complexity, and Investment, WP/18/107, May 2018 (PDF)