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Consumption and real exchange rates with incomplete markets and non-traded goods

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  • Gianluca Benigno
  • Christoph Theonissen

Abstract

This paper addresses the consumption-real exchange rate anomaly. International real business cycle models based on complete financial markets predict a unitary correlation between the real exchange rate and the ratio of home to foreign consumption when subjected to supply side shocks. In the data, this correlation is usually small and often negative. This paper shows that this anomaly can be successfully addressed by models that have an incomplete financial market structure and a non-traded as well as traded goods production sector.

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File URL: http://eprints.lse.ac.uk/3758/
File Function: Open access version.
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 3758.

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Length: 38 pages
Date of creation: Dec 2006
Date of revision:
Handle: RePEc:ehl:lserod:3758

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Keywords: Consumption-real exchange rate anomaly; incomplete financial markets; nontraded goods;

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References

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  1. Pierpaolo Benigno, 2008. "Price stability with imperfect financial integration," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  8. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report, Federal Reserve Bank of Minneapolis 146, Federal Reserve Bank of Minneapolis.
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  16. Rabanal, Pau & Tuesta Reátegui, Vicente, 2006. "Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model: What is Important and What is Not," CEPR Discussion Papers 5957, C.E.P.R. Discussion Papers.
  17. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers, Rutgers University, Department of Economics 200115, Rutgers University, Department of Economics.
  18. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  19. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  20. Rachel L. Ngai, 2007. "An R&D-based Model of Multi-sector Growth," 2007 Meeting Papers, Society for Economic Dynamics 349, Society for Economic Dynamics.
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  22. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers, Queen's University, Department of Economics 1252, Queen's University, Department of Economics.
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