Foreign Direct Investment and Inflation

Selin Sayek

67 citations0/0 files storedSouthern Economic Journal

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International Business and FDI Monetary Policy and Economic Impact Global Financial Crisis and Policies

Abstract

Multinational enterprises (MNEs) are able to shift investments between home and host countries to minimize the negative effects of changes in the macroeconomic environment. This article formalizes a model that allows studying this investment‐smoothing behavior of MNEs facing inflation taxes in both the home and the host country. The MNE is allowed to invest in two economies, home and host, and to finance its foreign direct investment (FDI) either through domestic or foreign sources. The investment smoothing by the MNE is studied for cases of both vertical and horizontal FDI. The results suggest FDI is used as a hedging tool, mitigating the effects of inflation taxes even if there are no formal hedging mechanisms. The investment‐smoothing reaction of MNEs depends on the reason for investment, the financing sources of FDI, and the substitutability between factors of production. Finally, this investment‐smoothing possibility (FDI) reduces the real negative effects of inflation.

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References

1966International Investment and International Trade in the Product Cycle 1995Multinational Enterprises and the Global Economy.2001The nature and growth of vertical specialization in world trade 1998Integration of Trade and Disintegration of Production in the Global Economy 1984A Simple Theory of International Trade with Multinational Corporations 1934The Economics of Imperfect Competition.1991Exchange Rates and Foreign Direct Investment: An Imperfect Capital Markets Approach 1982Interest rates and currency prices in a two-country world

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