Foreign capital inflows, exchange rates, and government stability

Nadine McCloud, Michael S. Delgado () and Man Jin ()
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Michael S. Delgado: Purdue University
Man Jin: Oakland University

Empirical Economics, 2024, vol. 66, issue 3, No 1, 945-977

Abstract: 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.

Keywords: Foreign direct investment; Exchange rate; Government stability; Symbiosis; Parameter heterogeneity; Semiparametric system of equations model (search for similar items in EconPapers)
JEL-codes: C14 C26 E02 F21 F31 O19 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s00181-023-02490-y

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