Is inflation targeting or the fixed exchange rate more effective for attracting FDI into developing countries?

ABSTRACT

This article investigates which monetary policy regime – inflation targeting or the fixed exchange rate – is more effective for attracting FDI inflows into developing countries. Using propensity score matching and the difference-in-differences estimator, we find no evidence that adopting an inflation targeting regime would be more effective than adopting a fixed exchange rate, and vice versa, in encouraging FDI inflows.

KEYWORDS:

• Inflation targeting
• fixed exchange rate
• FDI

JEL CLASSIFICATION:

• C21
• E52
• E58
• F21
• F31

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Developing countries here mostly refer to middle-income counties but not lower income or least developing countries.

² See, for example, Abbott, Cushman, and De Vita (2012) for fixed exchange rates and Tapsoba (2012) for inflation targeting.

³ See, for example, Lin and Ye (2012) and Tapsoba (2012) for a discussion on the covariates choice for the two approaches. We have also tried using the same set of covariates for and for both PSM and DiD approaches, e.g. all the covariates found in Column (4) of Table 1 and Column (4) of Table 3, and found that our main conclusion about the effectiveness of inflation targeting versus adopting a fixed exchange rate for attracting FDI remains the same.

⁴ We have checked that covariates are balanced across treatment and comparison groups.