DIRECT-INVESTMENT, HYSTERESIS, AND REAL EXCHANGE-RATE VOLATILITY

Recent papers by Dixit and others have put forth the argument that rea l exchange shocks generate a condition of hysteresis in the export ent ry and exit prices, and that this wedge in prices explains the persist ence in the U.S. current account deficit. This article shows that the critical hysteresis bounds for exports are altered dramatically by the additional option to locate manufacturing in the United States. We de velop a model that incorporates simultaneously the option to exit from a foreign country along with the option to invest in manufacturing fa cilities. The numerical simulations provide strong qualifications to t he relationship between hysteresis in export prices and the persistenc e of the current account deficit. (C) 1996 Academic Press, Inc.