Anticipated real exchange-rate changes and the dynamics of investment

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.Economic Theory&Research,International Terrorism&Counterterrorism,Environmental Economics&Policies,Macroeconomic Management,Banks&Banking Reform