Exchange Rate Variability and Direct Investment

Abstract

This article investigates the relationship between exchange rate variability and direct investment. We distinguish between two kinds of exchange rate variations: short-term volatility and longer-term misalignment. Theoretical considerations indicate that the influences of both kinds of exchange rate variations on direct investment are ambiguous. We then review the empirical literature on this issue, which supports the theoretical findings. We conclude that, contrary to the arguments of proponents of managed exchange rate regimes, the increased variability of exchange rates under the managed floating system has not been harmful to direct investment.