Exchange-rate strategies in the competition for attracting foreign direct investment

Building on the needs for long-term capital inflows in developing countries, this paper reconsiders the choice of an exchange-rate regime by integrating the determinants of multinational firms' locations. The trade-off between price competitiveness and a stable nominal exchange rate is modeled. Empirical results show that exchange-rate volatility is detrimental to foreign direct investment (FDI) anti that its impact compares with that of misalignments. One policy implication is that the building of currency blocks could be a way of increasing FDI to emerging countries as a whole. The frontiers of monetary areas would then be strongly influenced by geography, as FDI is.