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Uncertainty, Flexible Exchange Rates, and Agglomeration Luca Antonio Ricci

Uncertainty, Flexible Exchange Rates, and Agglomeration

Luca Antonio Ricci

Published February 1st 1998
ISBN : 9786613882455
ebook
35 pages
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This paper offers a theoretical explanation for a positive effect of exchange rate variability on agglomeration of economic activity. It shows that exchange rate variability induces greater variability of sales for firms located in small markets thanMoreThis paper offers a theoretical explanation for a positive effect of exchange rate variability on agglomeration of economic activity. It shows that exchange rate variability induces greater variability of sales for firms located in small markets than for those located in large markets, generating an incentive for firms to locate in large markets. Empirical evidence from OECD countries supports the prediction of the model presented in this paper. First, flexible exchange rates widen the gap between the variability of industrial output in small and large countries. Second, for small countries, variability of exchange rates has a negative long-run effect on the flow of net inward foreign direct investment (FDI), while for large countries this effect is positive, suggesting that such variability fosters agglomeration.