Investment and Exchange Rate Under Uncertainty
16 Pages Posted: 1 Aug 2003
Date Written: August 2003
The literature on the relationship between exchange rate and investment mainly focuses on the devaluation argument, which provides evidence that a devaluation may positively affect investment spending. The goal of this paper is to extend the analysis to how exchange rate variability can influence firm innovation process. Employing a large panel of Italian firms and using a model of signal extraction we find that exchange rate volatility reduces investment, with a decreasing sensitivity the greater the firm market power. A stable exchange rate is then an incentive to invest as it allows a more reliable estimation of its marginal productivity. To this extent, any economic system may benefit from a stable exchange rate in terms of investment and profit, provided it is able to strengthen its firm market power.
Keywords: exchange rate, firm heterogeneity, investment, uncertainty
JEL Classification: D81, E22, F41, F42
Suggested Citation: Suggested Citation