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

_IMF Working Papers, March 1, 1992_

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**Canonical URL:** [Exchange Rate Flexibility, Volatility and the Patterns of Domestic and Foreign Direct Investment](https://www.imf.org/en/publications/wp/issues/2016/12/30/exchange-rate-flexibility-volatility-and-the-patterns-of-domestic-and-foreign-direct-investment-772)

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## Bibliographic details
- Authors: Joshua Aizenman
- Published: March 1, 1992
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451843798.001

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### Summary and main findings
- Investigates factors determining the impact of exchange rate regimes on the behavior of domestic investment and foreign direct investment (FDI).
- Producers may diversify internationally to increase the flexibility of production.
- Characterizes possible equilibria in a macro model that allows for the presence of a short-run Phillips curve.
- A fixed exchange rate regime is more conducive to FDI relative to a flexible exchange rate; this conclusion applies for both real and nominal shocks.
- If the dominant shocks are nominal (real) we will observe a negative (a positive) correlation between exchange rate volatility and the level of investment.

### Model and mechanisms
- Uses a macro model incorporating a short-run Phillips curve.
- Emphasizes producers’ incentives to diversify internationally to increase production flexibility.
- Analysis covers both real and nominal shocks and derives implications for investment patterns under different exchange rate regimes.

### Policy implications and interpretation
- Fixed exchange rate regimes tend to promote higher FDI relative to flexible regimes.
- The sign of the correlation between exchange rate volatility and investment depends on the nature of dominant shocks:
  - Dominant nominal shocks → negative correlation between exchange rate volatility and investment.
  - Dominant real shocks → positive correlation between exchange rate volatility and investment.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/exchange-rate-flexibility-volatility-and-the-patterns-of-domestic-and-foreign-direct-investment-772_