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News Shocks, Real Exchange Rates and International Co-Movements

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  • Kyriacos Lambrias

Abstract

We propose a fully flexible, complete-market model of the international business cycle that is consistent with two major empirical facts: positive cross-country co-movement of economic aggregates and a negative correlation between the real exchange rate and relative consumption (the Backus-Smith puzzle). The model features non-tradable goods, zero wealth effects on labour supply, imperfect substitutability of capital across sectors and variable capacity utilisation. The latter can generate strong Balassa-Samuelson effects that drive a low consumption-real exchange rate correlation. Cyclical movements across countries are also positively correlated. The novelty of our paper is to introduce changes in expectations (news-shocks) as an explanation to the Backus-Smith puzzle through the wealth effects of future changes in income, while being consistent with expectations-driven economic expansions.

Suggested Citation

  • Kyriacos Lambrias, 2013. "News Shocks, Real Exchange Rates and International Co-Movements," BCL working papers 83, Central Bank of Luxembourg.
    • Handle: RePEc:bcl:bclwop:bclwp083
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    Cited by:

    1. Paul Beaudry & Franck Portier, 2014. "News-Driven Business Cycles: Insights and Challenges," Journal of Economic Literature, American Economic Association, vol. 52(4), pages 993-1074, December.
    2. Bianca De Paoli & Hande Küçük, 2015. "News shocks, monetary policy, and foreign currency positions," Staff Reports 750, Federal Reserve Bank of New York.
    3. Daniele Siena, 2017. "What's News in International Business Cycles," 2017 Meeting Papers 1206, Society for Economic Dynamics.

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    More about this item

    Keywords

    News-Driven Cycles; Backus-Smith Puzzle; Real-Exchange Rates;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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