On investment and exchange-rate movements

Abstract

We investigate the ways in which permanent exchange-rate changes may affect investment by influencing domestic and foreign revenue, the cost of imported variable inputs and the investment price of imported capital goods. We find that the revenue and investment-price channels have a quantitatively greater effect on investment than the cost channel. The negative effect of the revenue channel, which affects the marginal profitability of capital, outweighs the positive effect of the investment-price channel, which affects the marginal cost of capital, implying that exchange-rate appreciation has a net negative influence on investment. The estimation results are robust to different approaches to extracting the permanent components of exchange rates.

Modelling a Small Open Economy Using a Wavelet-Based Control Model

“…Longer-term investment (d5) is clearly hurt by the consistently tighter monetary policy required to keep the real exchange rate relatively constant throughout the forecast period, as is investment at the shortest frequency range (d1). The negative influence on investment associated with the appreciated RER trajectory is consistent with findings of Ng and Souare (2014).…”