The Effect of Inflation Targeting on Foreign Direct Investment Flows to Developing Countries

Abstract

Due to the many benefits that come with foreign direct investment (FDI), such as greater economic growth and technology spillovers, developing countries strive to attract this type of investment. Although the amount of FDI in developing countries has increased greatly over the past several years, not all developing countries have been successful at attracting it. A credible monetary policy, such as inflation targeting (IT), might make countries that implement it more attractive destinations for FDI flows due to the reliable macroeconomic environment created. This paper estimates the effect of IT on FDI flows to developing countries using a difference-in-differences approach and panel data for 71 countries for the period 1985 to 2013. This paper also looks at the difference between targeting and non-targeting countries in terms of FDI inflows during times of high instability. The results indicate that the adoption of IT leads to increased FDI flows to developing countries overall and, most importantly, during times of distress.