Bilateral and Third‐Country Exchange Rate Effects on Multinational Activity

Abstract

In an earlier paper, we showed that bilateral exchange rates are important determinants of multinational activity of both the US and Japan and that increases in the bilateral and third‐country exchange rates exert opposing effects on bilateral multinational activity. Furthermore, the signs of the exchange rate coefficients differ between Japan and the US. In this paper, we formulate a three‐country model with coexisting exporters and multinational firms that engage in Cournot competition to rationalize these effects. In this model, we identify two counteracting effects which govern the bilateral and third‐country effects of an exchange rate increase on bilateral multinational activity. Our theoretical framework is flexible enough to explain the Japanese as well as the US patterns of exchange rate effects and it allows us to identify those factors that are responsible for the respective differences.