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Anticipated real exchange-rate changes and the dynamics of investment

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  • Serven, Luis
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    Abstract

    The impact of permanent real depreciation on a country's capital stock is uncertain. Whether total capital stock rises or falls depends on how depreciation affects aggregate demand, the real interest rate, and especially the import content of capital goods. In the long run, the capital stock can be expected to rise in traded goods and fall in nontraded goods. Despite this long-run ambiguity, anticipated changes in real exchange rate have a predictable effect on the dynamics of capital accumulation. They provide an incentive for speculative rellocation of investment over time, so they can greatly distort the timing of investments. In the framework of this paper, the time profile of investment is related to how financially open an economy is and to the import content of capital goods. When a real depreciation is expected, an investment boom is likely to develop if the import content of capital goods is high relative to the degree of capital mobility: the anticipated depreciation promotes flight into foreign goods. Conversely, with high capital mobility, the opposite investment pattern is likely to emerge, as the anticipated depreciation promotes flight into foreign assets.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 562.

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    Date of creation: 31 Dec 1990
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    Handle: RePEc:wbk:wbrwps:562

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    Keywords: Economic Theory&Research; International Terrorism&Counterterrorism; Environmental Economics&Policies; Macroeconomic Management; Banks&Banking Reform;

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    1. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-24, January.
    2. Blanchard, Olivier J, 1981. "Output, the Stock Market, and Interest Rates," American Economic Review, American Economic Association, vol. 71(1), pages 132-43, March.
    3. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
    4. Buffie, Edward F., 1986. "Devaluation, investment and growth in LDCs," Journal of Development Economics, Elsevier, vol. 20(2), pages 361-379, March.
    5. J. Saul Lizondo & Peter J. Montiel, 1989. "Contractionary Devaluation in Developing Countries: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 36(1), pages 182-227, March.
    6. Buiter, Willem H, 1984. "Saddlepoint Problems in Continuous Time Rational Expectations Models: A General Method and Some Macroeconomic Examples," Econometrica, Econometric Society, vol. 52(3), pages 665-80, May.
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