Exchange-Rate Strategies in the Competition for Attracting Foreign Direct Investment

Building on the needs for long-term capital inflows in developing countries, this paper reconsiders the choice of an exchange-rate regime by integrating the determinants of multinational firms' locations. The trade-off between price competitiveness and a stable nominal exchange rate is modeled. Empirical results show that exchange-rate volatility is detrimental to foreign direct investment (FDI) and that its impact compares with that of misalignments. One policy implication is that the building of currency blocks could be a way of increasing FDI to emerging countries as a whole. The frontiers of monetary areas would then be strongly influenced by geography, as FDI is. J. Japan. Int. Econ., June 2001, 15(2), pp. 178–198. University of Paris X-Nanterre (THEMA) and CEPII, 200 avenue de la République F-92000 Nanterre, France, CEPII and TEAM, 9 rue Georges Pitard F-75015 Paris, France, (University of Amiens (CRIISEA), CEPII and TEAM, 9 rue Georges Pitard F-75015 Paris, France). Copyright 2001 Academic Press. Journal of Economic Literature Classification Numbers: F21, F23, F31, F33.