Investment and the exchange rate: An analysis with firm-level panel data

This paper investigates the relationship between exchange rate fluctuations and the investment decisions of a sample of Italian manufacturing firms. T he results support the View that a depreciation of the exchange rate has a positive effect on investment through the revenue channel, and a negative e ffect through the cost channel. The magnitude of these effects varies over time with changes in the firm's external orientation, as measured by the sh are of foreign sales over total sales and the reliance on imported inputs. Consistent with the predictions of our theoretical framework, the effect of exchange rate fluctuations on investment is stronger for firms with low mo nopoly power, facing a high degree of import penetration in the domestic ma rket, and of a small size. We also provide evidence that the degree of subs titutability between domestically produced and imported inputs influences t he effect through the expenditure side. (C) 2001 Elsevier Science B.V. All rights reserved.