Exchange rate regime flexibility and firms’ employment

This paper examines how exchange rate regime flexibility impacts the allocation of labor across firms. Specifically, we investigate how differences in labor-intensity or capital-intensity in production affect employment decisions under various degrees of exchange rate regime flexibility. In a simple theoretical model, we show that firms utilizing more labor-intensive production technologies are more likely to expand their employment when the exchange rate they face becomes less flexible. In contrast, firms employing more capital-intensive technology tend to hire more workers when the exchange rate is more flexible. We test our theory using granular firm-level data from China and provide robust evidence supporting the theoretical predictions. • We shift focus from exchange rate levels to how regime flexibility influences firms’ employment decisions. • Capital-intensive firms gain from flexible exchange rates, while labor-intensive firms prefer fixed regimes to reduce uncertainty. • After China’s 2005 move to a managed float, labor-intensive firms increase employment more when FX flexibility is lower. • Firm characteristics, particularly labor intensity in production, are crucial drivers of how companies respond to exchange rate regime changes.