Devaluation and investment in an optimizing model of the small open economy

We analyze the impact of devaluation on sectoral investment, aggregate inve stment, and real output in a fully articulated, optimizing model of a small open economy where installed capital is sector-specific and new capital go ods are constructed by combining nontraded inputs with non-competitive impo rted machines. Investment falls when the intertemporal elasticity of substi tution and the share of domestically produced capital goods are not implaus ibly large, This result is robust to a wide range of parameter values and t o the possibility that saving-investment decisions are made by heterogeneou s agents instead of a representative agent. (C) 2001 Elsevier Science B.V. All rights reserved.