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Foreign capital inflows, exchange rates, and government stability

Author

Listed:
  • Nadine McCloud

    (University of the West Indies at Mona)

  • Michael S. Delgado

    (Purdue University)

  • Man Jin

    (Oakland University)

Abstract

In theory, changes in a host country exchange rate can be a cause or consequence of changes in its level of foreign direct investment (FDI), and recent incidences suggest that government stability may have sizable implications for the interactions between FDI and the exchange rate. This paper uses a semiparametric system of simultaneous equations to empirically characterize the relationship between FDI and the exchange rate, with each country’s level of government stability serving as a moderator. The results suggest that across developed and developing economies the most prevalent type of symbiosis between FDI and the exchange rate is a positive effect of FDI on the exchange rate, but no effect of the exchange rate on FDI. This significant FDI effect is heterogeneous, with an interquartile range of 1.241. At the median, a 10% increase in FDI inflows relative to GDP causes approximately a 13.29% increase in the annual change in the exchange rate. Government stability acts as a moderator variable by strengthening the relationship between FDI and the exchange rate in some countries, but eliminates the relationship in other countries.

Suggested Citation

  • Nadine McCloud & Michael S. Delgado & Man Jin, 2024. "Foreign capital inflows, exchange rates, and government stability," Empirical Economics, Springer, vol. 66(3), pages 945-977, March.
    • Handle: RePEc:spr:empeco:v:66:y:2024:i:3:d:10.1007_s00181-023-02490-y
    DOI: 10.1007/s00181-023-02490-y
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    More about this item

    Keywords

    Foreign direct investment; Exchange rate; Government stability; Symbiosis; Parameter heterogeneity; Semiparametric system of equations model;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C26 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Instrumental Variables (IV) Estimation
    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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