The paper analyzes the way in which macroeconomic volatility influences the performances of economic growth and social welfare. The analysis is made on the basis of a stochastic endogenous growth model for a small open economy that can receive foreign direct investment (FDI). There are two sources of uncertainty in the model: stochastic productivity and foreign price shocks, respectively.

The representative agent maximizes a recursive utility function as defined by Epstein-Zin, Svensson and Weil.

The technology is of Cobb-Douglas type, with technical progress, where the total factor productivity (TFP) obeys an Ito type stochastic process. At the same time, it is assumed that the real exchange rate also obeys an Ito type stochastic process, uncorrelated with the TFP process.

The optimality conditions are obtained by using the Maximum Principle for stochastic dynamic systems. A qualitative analysis of the optimal trajectories is performed, on the basis of the information provided by the Maximum Principle, concerning the dynamics of the dual variable.

Finally, we analyze the influence of volatility on the process of economic growth. We also estimate measures of the total welfare cost of volatility.