Monetary and Real Shocks, Productive Capacity and Exchange Rate Regimes.

This paper constructs an intertemporal version of a monopolistic competitive framework where producers may diversify internationally. International diversification is shown to induce a positive correlation between the volatility of productivity shocks and investment. In the presence of a Phillips curve, the expected GNP is lower under a floating-exchange-rate regime than under a fixed-exchange-rate regime. This result applies both for real and monetary shocks. Attempts to reduce foreign direct investment by capital controls will tend to reduce welfare without affecting the author's results regarding the ranking of exchange-rate regimes. Copyright 1994 by The London School of Economics and Political Science.