Abstract
The impact of exchange rate uncertainty on domestic investment remains a topical issue in international finance. The existing studies based on macro- or micro-level data have produced mixed findings leaving the issue widely open for further investigation. We revisit this issue at the macro-level by differentiating the short-run impacts of exchange rate uncertainty from long-run impacts. Using annual data for Ghana covering the period 1980–2015, we found that exchange rate uncertainty has differential impacts on domestic investment in the short run. That is, while the current level of uncertainty enhances investment, previous levels of uncertainty dampen investment. In the long run, exchange rate uncertainty has a positive impact on domestic investment. These findings are robust to alternative specifications of our model.
Highlights
Modern economies favour flexible over fixed exchange rate arrangements
As a preview of our results, we found that exchange rate uncertainty has differential impacts on domestic investment in the short run
Exchange rate uncertainty has a positive impact on domestic investment
Summary
The commonly practised flexible exchange rate arrangement is the managed-float or dirty-float, whereby monetary authorities allow the value of local currency against foreign ones to be determined by market forces, and occasionally intervene during periods when the currency deviates from its equilibrium. This exchange rate arrangement creates volatilities or uncertainties in the real exchange rate. On the one hand, Hartman (1972) and Abel (1985) argue that the high price uncertainty may promote current levels of investment by competitive risk-neutral firms in their attempt to prevent uncertainty in the future. On the other, Pindyck (1988) and Bertola (1998) demonstrate that high uncertainty reduces the investment process by risk-neutral firms
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