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Research department working papers, a fundamental connection: exchange rates and macroeconomic expectations.

An emerging perception in international economics is that exchange rates are disconnected contemporaneously from macroeconomic fundamentals and are instead more closely tied to financial variables, particularly asset prices. The authors argue that this notion is incorrect. They use novel econometric methods to show that, while quarterly exchange rate changes are tightly linked to movements in currency risk premia, new information revealed by announcements about macroeconomic indicators can explain much of the variation in these risk premia. They also show that this same macroeconomic news also explains most of the variation in exchange rate changes at a quarterly frequency and that this news has even greater explanatory power during economic downturns and periods of financial uncertainty.

• Nadine McCloud 1 ,
• Michael S. Delgado 2 &
• Man Jin 3  

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In theory, changes in a host country exchange rate can be a cause or consequence of changes in its level of foreign direct investment (FDI), and recent incidences suggest that government stability may have sizable implications for the interactions between FDI and the exchange rate. This paper uses a semiparametric system of simultaneous equations to empirically characterize the relationship between FDI and the exchange rate, with each country’s level of government stability serving as a moderator. The results suggest that across developed and developing economies the most prevalent type of symbiosis between FDI and the exchange rate is a positive effect of FDI on the exchange rate, but no effect of the exchange rate on FDI. This significant FDI effect is heterogeneous, with an interquartile range of 1.241. At the median, a 10% increase in FDI inflows relative to GDP causes approximately a 13.29% increase in the annual change in the exchange rate. Government stability acts as a moderator variable by strengthening the relationship between FDI and the exchange rate in some countries, but eliminates the relationship in other countries.

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Based on World Bank data, between 2003 and 2013, Angola’s economy grew at an annual average of about 10.3% relative to all of Sub-Saharan Africa which grew by an average of approximately 5.7%.

See, e.g., Froot and Stein ( 1991 ), Broll and Wahl ( 1992 ), Blonigen ( 1997 ), Cushman ( 1985 ), Campa ( 1993 ), Aizenman ( 1992 ), Goldberg and Kolstad ( 1994 ), Campa and Goldberg ( 1995 ), Kiyota and Urata ( 2004 ), Russ ( 2007 ), Udomkerdmongkol et al. ( 2009 ), Yu and Walsh ( 2010 ), Alba et al. ( 2010 ).

Here, we avail ourselves of the symbiosis taxonomy in the biological literature to characterize the interactions between FDI inflows and changes in exchange rates.

Regarding the political economy determinants of FDI, see for example Schneider and Frey ( 1985 ), Hines ( 1995 ), Wei ( 2000 ), Harms and Ursprung ( 2002 ), Egger and Winner ( 2005 ), Egger and Winner ( 2006 ), Hakkala et al. ( 2008 ), Kolstad and Villanger ( 2008 ), Asiedu et al. ( 2009 ), Faeth ( 2009 ), Javorcik and Wei ( 2009 ), Aleksynska and Havrylchyk ( 2013 ), Sánchez-Martín et al. ( 2014 ), Akhtaruzzaman et al. ( 2017 ) and the references cited therein; and for exchange rates, see Bodea ( 2015 ), Beckmann et al. ( 2017 ), Beckmann and Czudaj ( 2017 ) and the references cited therein.

There is a broad literature studying the effect of capital inflows on productivity, that pays particularly close attention to relevant spillover effects. The hypothesis is that FDI often involves the transfer of knowledge from one country/firm to another (Keller 2004 ), and it facilitates gaining access to intangible productive “knowledge” assets from abroad such as new technologies, proprietary know-hows, more efficient and innovative marketing and management practices, established relational networks, or reputation, which can boost productivity of domestic firms. The effect is commonly referred to as the FDI spillover. Empirically, many studies find robust evidence that FDI has a positive effect on productivity for both immediate recipients, who benefit from direct learning of foreign knowledge, and other domestic firms in the region via technology/knowledge spillovers (Potterie and Lichtenberg 2001 ; Baldwin et al. 2005 ; Keller and Yeaple 2009 ; Malikov and Zhao 2021 ; Smarzynska Javorcik 2004 ).

For instance, Kosteletou and Liargovas ( 2000 ) empirically examine causality between the exchange rate and FDI for 12 EU countries using a simultaneous linear equation model where FDI and the exchange rate are jointly determined. They find that in large countries with freely floating currencies causality runs from the exchange rate to FDI, but that causality runs both ways in small countries with fixed or “quasi” fixed currencies. While we also focus on bidirectional links between the exchange rate and FDI, in contrast to Kosteletou and Liargovas ( 2000 ), we do not restrict our attention to either a limited sample of countries or to a linear regression setup.

There are also some work using bilateral exchange rate (Yuqing 2006 ) and effective exchange rate (Huong et al. 2020 ) to discuss the relationship between exchange rate and FDI in Asian countries.

There is a broader literature that looks at the link between trade openness and exchange rate volatility. For example, Calderón and Kubota ( 2018 ) find that higher trade openness leads to a more stable exchange rate, while Harms and Ursprung ( 2002 ) shows that monetary and supply shocks produce smaller exchange rate movements if an economy is more open to trade. Giovanni and Levchenko ( 2009 ) show that sectors more open to international trade are more volatile. A high GDP reflects larger production rates, an indication of greater demand for that country’s products. An increase in demand for a country’s goods and services often translates into increased demand for the country’s currency.

Note that this government stability index is available for 1984 and onwards, which inevitably fixes the beginning year of our dataset. Moreover, the current account data is not available after 2010. Therefore, our annual data series runs from 1984 to 2010.

Barro ( 1991 ) and Brunetti and Weder ( 1998 ) find empirical evidence that government instability is significantly related to cross-country differences in private investment.

Moreover, the Racine and Li ( 2004 ) kernels allow for interaction of unknown form between both fixed effects and variables that vary both across country and over time, so that our control of country- and year-specific effects is not restricted to additively separable effects.

With exception of the country and year indicators, we require the variables in \(Z_{it}\) to vary across both i and t , thus allowing our country and year indicators to absorb all country or time-varying factors that may lead to heterogeneity in the coefficient functions.

Our use of non-neutral fixed effects—in lieu of their neutral counterparts—circumvents the need to remove the fixed effects via some type of weighting or first difference transformation prior to estimation, to avoid biased and inconsistent estimates of, in particular, the marginal effects. Further, our use of generalized product kernels (Racine and Li 2004 ) allows us to avoid the incidental parameters problem associated with many parametric panel models that include dummy variables to account for unobserved effects.

We consider estimates of (A9) that use first stage estimates of A as our weighting matrix.

We use the Li et al. ( 2009 ) density equality test as a means to test whether the coefficient distributions estimated via the semiparametric simultaneous equations system are different from the coefficient distributions estimated by an equation-by-equation semiparametric estimator. The tests indicate that there are significant differences between the estimated coefficient distributions for both \(\Delta E\) and FDI across model specifications. We take this as support for our simultaneous equations structure.

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Department of Economics, University of the West Indies at Mona, Kingston 7, Jamaica

Nadine McCloud

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Bryan Black and Rosan Reynolds-Salmon provided research assistance. We are grateful to participants at the 26th Silvaplana Workshop in Political Economy 2017 for comments. A previous draft of this paper was titled “A mutualism analysis of capital inflows and exchange rates: Does government stability matter?”.

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McCloud, N., Delgado, M.S. & Jin, M. Foreign capital inflows, exchange rates, and government stability. Empir Econ 66 , 945–977 (2024). https://doi.org/10.1007/s00181-023-02490-y

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Received : 11 July 2022

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Published : 18 November 2023

Issue Date : March 2024

DOI : https://doi.org/10.1007/s00181-023-02490-y

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• Foreign direct investment
• Exchange rate
• Government stability
• Parameter heterogeneity
• Semiparametric system of equations model

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Research on exchange rates and monetary policy: an overview

This paper reviews research carried out on exchange rates and monetary policy by central banks that participated at the Autumn Meeting of Central Bank Economists on "Exchange rates and monetary policy", which the BIS hosted on 28-29 October 2004. The first part of the paper focuses on the approaches that central banks have found most useful in modelling exchange rate behaviour. We describe efforts to explain exchange rate behaviour ex post and to forecast its future evolution ex ante. We then summarise central banks' recent research on the linkage between exchange rates and inflation, output, profits and the current account. We highlight the main models and methodologies, the main empirical results and the key challenges ahead. The second part of the paper is devoted to research that examines the actual experience that countries have had in incorporating the exchange rate into their monetary policy decisions, and the main lessons learned.

JEL Classification Numbers: E5, F3, F4

Keywords: Monetary Policy, International Finance, Macroeconomic Aspects of International Trade and Finance

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Exchange Rate Exposure

In this paper we examine the relationship between exchange rate movements and firm value. We estimate the exchange rate exposure of publicly listed firms in a sample of eight (non-US) industrialized and emerging markets, and find that a significant percentage of these firms are indeed exposed. These results differ substantially from most previous studies in the literature that find little evidence of exposure. In robustness checks we find that: (i) the choice of exchange rate matters, and using the trade-weighted exchange rate is likely to understate the extent of exposure, (ii) conditioning on the value-weighted vs. the equally-weighted market index has little effect on estimated exposure, while conditioning on the international index does change the estimate of exposure, (iii) the extent of exposure is not a result of a spurious correlation between random variables with high variances, (iv) exposure increases with the return horizon, (v) within a country and within an industry, exposure coefficients are roughly evenly split between positive and negative values, (vi) averaging across the (absolute value of the) significant exposure coefficients in our sample of countries, we find an exposure coefficient of about 0.5, (vii) the extent of exposure is not sensitive to the sample period, but the set of firms that is exposed does vary over time, and (viii) the sign of the exposure coefficients changes across subperiods for about half of the firms of our sample. We find that exposure is not systematically related to firm size, industry affiliation, multinational status, foreign sales, international assets or industry-level trade.

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PAUL F. GNIRK  (Ph.D. 1966) passed away January 29, 2024, at the age of 86. A memorial service was held Saturday, February 24, at the South Dakota School of Mines and Technology (SDSM&T), where he started and ended his teaching career, though he had many other positions, professional and voluntary. In 2018 Paul was inducted into the SDSM&T Hardrocker Hall of Fame, and in 2022, he was inducted into the South Dakota Hall of Fame, joining his mother Adeline S. Gnirk, who had been inducted in 1987 for her work authoring nine books on the history of south central South Dakota.

ROGER M. HILL  (BCE 1957) passed away on January 13, 2024, at the age of 90. His daughter, Kelly Robinson, wrote to CEGE that Roger was “a dedicated Gopher fan until the end, and we enjoyed many football games together in recent years. Thank you for everything.”

KAUSER JAHAN  (Ph.D. 1993, advised by Walter Maier), PE, is now a civil and environmental engineering professor and department head at Henry M. Rowan College of Engineering. Jahan was awarded a 3-year (2022- 2025), $500,000 grant from the U.S. Department of Environmental Protection Agency (USEPA). The grant supports her project, “WaterWorks: Developing the New Generation of Workforce for Water/Wastewater Utilities,” for the development of educational tools that will expose and prepare today’s students for careers in water and wastewater utilities.

SAURA JOST  (BCE 2010, advised by Timothy LaPara) was elected to the St. Paul City Council for Ward 3. She is part of the historic group of women that make up the nation’s first all-female city council in a large city.

The 2024 ASCE Western Great Lakes Student Symposium combines several competitions for students involved in ASCE. CEGE sent a large contingent of competitors to Chicago. Each of the competition groups won awards: Ethics Paper 1st place Hans Lagerquist; Sustainable Solutions team 1st place overall in (qualifying them for the National competition in Utah in June); GeoWall 2nd place overall; Men’s Sprint for Concrete Canoe with rowers Sakthi Sundaram Saravanan and Owen McDonald 2nd place; Product Prototype for Concrete Canoe 2nd place; Steel Bridge (200 lb bridge weight) 2nd place in lightness; Scavenger Hunt 3rd place; and Aesthetics and Structural Efficiency for Steel Bridge 4th place.

Students competing on the Minnesota Environmental Engineers, Scientists, and Enthusiasts (MEESE) team earned second place in the Conference on the Environment undergraduate student design competition in November 2023. Erin Surdo is the MEESE Faculty Adviser. Pictured are NIKO DESHPANDE, ANNA RETTLER, and SYDNEY OLSON.

The CEGE CLASS OF 2023 raised money to help reduce the financial barrier for fellow students taking the Fundamentals of Engineering exam, a cost of $175 per test taker. As a result of this gift, they were able to make the exam more affordable for 15 current CEGE seniors. CEGE students who take the FE exam pass the first time at a rate well above national averages, demonstrating that CEGE does a great job of teaching engineering fundamentals. In 2023, 46 of 50 students passed the challenging exam on the first try.

This winter break, four CEGE students joined 10 other students from the College of Science and Engineering for the global seminar, Design for Life: Water in Tanzania. The students visited numerous sites in Tanzania, collected water source samples, designed rural water systems, and went on safari. Read the trip blog: http://globalblogs.cse.umn.edu/search/label/Tanzania%202024

Undergraduate Honor Student  MALIK KHADAR  (advised by Dr. Paul Capel) received honorable mention for the Computing Research Association (CRA) Outstanding Undergraduate Research Award for undergraduate students who show outstanding research potential in an area of computing research.

GRADUATE STUDENTS

AKASH BHAT  (advised by William Arnold) presented his Ph.D. defense on Friday, October 27, 2023. Bhat’s thesis is “Photolysis of fluorochemicals: Tracking fluorine, use of UV-LEDs, and computational insights.” Bhat’s work investigating the degradation of fluorinated compounds will assist in the future design of fluorinated chemicals such that persistent and/or toxic byproducts are not formed in the environment.

ETHAN BOTMEN  (advised by Bill Arnold) completed his Master of Science Final Exam February 28, 2024. His research topic was Degradation of Fluorinated Compounds by Nucleophilic Attack of Organo-fluorine Functional Groups.

XIATING CHEN , Ph.D. Candidate in Water Resources Engineering at the Saint Anthony Falls Laboratory is the recipient of the 2023 Nels Nelson Memorial Fellowship Award. Chen (advised by Xue Feng) is researching eco-hydrological functions of urban trees and other green infrastructure at both the local and watershed scale, through combined field observations and modeling approaches.

ALICE PRATES BISSO DAMBROZ  has been a Visiting Student Researcher at the University of Minnesota since last August, on a Doctoral Dissertation Research Award from Fulbright. Her CEGE advisor is Dr. Paul Capel. Dambroz is a fourth year Ph.D. student in Soil Science at Universidade Federal de Santa Maria in Brazil, where she studies with her adviser Jean Minella. Her research focuses on the hydrological monitoring of a small agricultural watershed in Southern Brazil, which is located on a transition area between volcanic and sedimentary rocks. Its topography, shallow soils, and land use make it prone to runoff and erosion processes.

Yielding to people in crosswalks should be a very pedestrian topic. Yet graduate student researchers  TIANYI LI, JOSHUA KLAVINS, TE XU, NIAZ MAHMUD ZAFRI  (Dept.of Urban and Regional Planning at Bangladesh University of Engineering and Technology), and Professor Raphael Stern found that drivers often do not yield to pedestrians, but they are influenced by the markings around a crosswalk. Their work was picked up by the  Minnesota Reformer.

TIANYI LI  (Ph.D. student advised by Raphael Stern) also won the Dwight David Eisenhower Transportation (DDET) Fellowship for the third time! Li (center) and Stern (right) are pictured at the Federal Highway Administration with Latoya Jones, the program manager for the DDET Fellowship.

The Three Minute Thesis Contest and the Minnesota Nice trophy has become an annual tradition in CEGE. 2023’s winner was  EHSANUR RAHMAN , a Ph.D. student advised by Boya Xiong.

GUANJU (WILLIAM) WEI , a Ph.D. student advised by Judy Yang, is the recipient of the 2023 Heinz G. Stefan Fellowship. He presented his research entitled Microfluidic Investigation of the Biofilm Growth under Dynamic Fluid Environments and received his award at the St. Anthony Falls Research Laboratory April 9. The results of Wei's research can be used in industrial, medical, and scientific fields to control biofilm growth.

BILL ARNOLD  stars in an award-winning video about prairie potholes. The Prairie Potholes Project film was made with the University of Delaware and highlights Arnold’s NSF research. The official winners of the 2024 Environmental Communications Awards Competition Grand Prize are Jon Cox and Ben Hemmings who produced and directed the film. Graduate student Marcia Pacheco (CFANS/LAAS) and Bill Arnold are the on-screen stars.

Four faculty from CEGE join the Center for Transportation Studies Faculty and Research Scholars for FY24–25:  SEONGJIN CHOI, KETSON ROBERTO MAXIMIANO DOS SANTOS, PEDRAM MORTAZAVI,  and  BENJAMIN WORSFOLD . CTS Scholars are drawn from diverse fields including engineering, planning, computer science, environmental studies, and public policy.

XUE FENG  is coauthor on an article in  Nature Reviews Earth and Environment . The authors evaluate global plant responses to changing rainfall regimes that are now characterized by fewer and larger rainfall events. A news release written at Univ. of Maryland can be found here: https://webhost.essic. umd.edu/april-showers-bring-mayflowers- but-with-drizzles-or-downpours/ A long-running series of U of M research projects aimed at improving stormwater quality are beginning to see practical application by stormwater specialists from the Twin Cities metro area and beyond. JOHN GULLIVER has been studying best practices for stormwater management for about 16 years. Lately, he has focused specifically on mitigating phosphorous contamination. His research was highlighted by the Center for Transportation Studies.

JIAQI LI, BILL ARNOLD,  and  RAYMOND HOZALSKI  published a paper on N-nitrosodimethylamine (NDMA) precursors in Minnesota rivers. “Animal Feedlots and Domestic Wastewater Discharges are Likely Sources of N-Nitrosodimethylamine (NDMA) Precursors in Midwestern Watersheds,” Environmental Science and Technology (January 2024) doi: 10.1021/acs. est.3c09251

ALIREZA KHANI  contributed to MnDOT research on Optimizing Charging Infrastructure for Electric Trucks. Electric options for medium- and heavy-duty electric trucks (e-trucks) are still largely in development. These trucks account for a substantial percentage of transportation greenhouse gas emissions. They have greater power needs and different charging needs than personal EVs. Proactively planning for e-truck charging stations will support MnDOT in helping to achieve the state’s greenhouse gas reduction goals. This research was featured in the webinar “Electrification of the Freight System in Minnesota,” hosted by the University of Minnesota’s Center for Transportation Studies. A recording of the event is now available online.

MICHAEL LEVIN  has developed a unique course for CEGE students on Air Transportation Systems. It is the only class at UMN studying air transportation systems from an infrastructure design and management perspective. Spring 2024 saw the third offering of this course, which is offered for juniors, seniors, and graduate students.

Research Professor  SOFIA (SONIA) MOGILEVSKAYA  has been developing international connections. She visited the University of Seville, Spain, November 13–26, 2023, where she taught a short course titled “Fundamentals of Homogenization in Composites.” She also met with the graduate students to discuss collaborative research with Prof. Vladislav Mantic, from the Group of Continuum Mechanics and Structural Analysis at the University of Seville. Her visit was a part of planned activities within the DIAGONAL Consortium funded by the European Commission. CEGE UMN is a partner organization within DIAGONAL, represented by CEGE professors Mogilevskaya and Joseph Labuz. Mantic will visit CEGE summer 2024 to follow up on research developments and discuss plans for future collaboration and organization of short-term exchange visits for the graduate students from each institution. 

DAVID NEWCOMB  passed away in March. He was a professor in CEGE from 1989–99 in the area of pavement engineering. Newcomb led the research program on asphalt materials characterization. He was the technical director of Mn/ROAD pavement research facility, and he started an enduring collaboration with MnDOT that continues today. In 2000, he moved from Minnesota to become vice-president for Research and Technology at the National Asphalt Pavement Association. Later he moved to his native Texas, where he was appointed to the division head of Materials and Pavement at the Texas A&M Transportation Institute, a position from which he recently retired. He will be greatly missed.

PAIGE NOVAK  won Minnesota ASCE’s 2023 Distinguished Engineer of the Year Award for her contributions to society through her engineering achievements and professional experiences.

The National Science Foundation (NSF) announced ten inaugural (NSF) Regional Innovation Engines awards, with a potential $1.6 billion investment nationally over the next decade. Great Lakes ReNEW is led by the Chicago-based water innovation hub,  Current,  and includes a team from the University of Minnesota, including PAIGE NOVAK. Current will receive $15 mil for the first two years, and up to $160 million over ten years to develop and grow a water-focused innovation engine in the Great Lakes region. The project’s ambitious plan is to create a decarbonized circular “blue economy” to leverage the region’s extraordinary water resources to transform the upper Midwest—Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin. Brewing one pint of beer generates seven pints of wastewater, on average. So what can you do with that wastewater?  PAIGE NOVAK  and her team are exploring the possibilities of capturing pollutants in wastewater and using bacteria to transform them into energy.

BOYA XIONG  has been selected as a recipient of the 2024 40 Under 40 Recognition Program by the American Academy of Environmental Engineers and Scientists. The award was presented at the 2024 AAEES Awards Ceremony, April 11, 2024, at the historic Howard University in Washington, D.C. 

JUDY Q. YANG  received a McKnight Land-Grant Professorship Award. This two-year award recognizes promising assistant professors and is intended to advance the careers of individuals who have the potential to make significant contributions to their departments and their scholarly fields. 

Professor Emeritus CHARLES FAIRHURST , his son CHARLES EDWARD FAIRHURST , and his daughter MARGARET FAIRHURST DURENBERGER were on campus recently to present Department Head Paige Novak with a check for $25,000 for the Charles Fairhurst Fellowship in Earth Resources Engineering in support of graduate students studying geomechanics. The life of Charles Fairhurst through a discussion with his children is featured on the Engineering and Technology History Wiki at https://ethw.org/Oral-History:Charles_Fairhurst#00:00:14_INTRODUCTION

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