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Traded and nontraded goods prices, and international risk sharing: an empirical investigation

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  • Corsetti, Giancarlo
  • Dedola, Luca
  • Viani, Francesca

Abstract

Accounting for the pervasive evidence of limited international risk sharing is an important hurdle for open-economy models, especially when these are adopted in the analysis of policy trade-offs likely to be affected by imperfections in financial markets. Key to the literature is the evidence, at odds with efficiency, that consumption is relatively high in countries where its international relative price (the real exchange rate) is also high. We reconsider the relation between cross-country consumption differentials and real exchange rates, by decomposing it into two components, reflecting the prices of tradable and nontradable goods, respectively. We document that, as a common pattern among OECD countries, both components tend to contribute to the overall lack of risk sharing, with the tradable price component playing the dominant role in accounting for efficiency deviations. We relate these findings to two mechanisms proposed by the literature to reconcile open economy models with the data. One features strong Balassa-Samuelson effects on nontradable prices due to productivity gains in the tradable sector, with a muted offsetting response of tradable prices. The other, endogenous income effects causing nontradable but especially tradable prices to appreciate with a rise in domestic consumption demand.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8613.

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Date of creation: Oct 2011
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Handle: RePEc:cpr:ceprdp:8613

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Keywords: consumption-real exchange rate anomaly; Harrod-Balassa-Samuelson effect; incomplete markets; international transmission mechanism; terms of trade;

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References

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Cited by:
  1. Kyriacos Lambrias, 2013. "News Shocks, Real Exchange Rates and International Co-Movements," BCL working papers 83, Central Bank of Luxembourg.
  2. A. Craig Burnside & Jeremy J. Graveline, 2012. "On the Asset Market View of Exchange Rates," NBER Working Papers 18646, National Bureau of Economic Research, Inc.
  3. Giancarlo Corsetti & Luca Dedola & Francesca Viani, 2012. "The international risk-sharing puzzle is at business-cycle and lower frequency," Banco de Espa�a Working Papers 1212, Banco de Espa�a.

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