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International and Intra-national Real Exchange Rates: Evidence and Theory

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  • Viktoria Hnatkovska

    (UBC)

  • Michael Devereux

    (UBC)

Abstract

In this paper we study two long-standing puzzles in the International Finance literature: the fact that the real exchange rate (RER) is very volatile (RER volatility puzzle) and that it covaries negatively with domestic consumption relative to foreign consumption (Backus-Smith puzzle). To understand the two puzzles we depart from the existing literature by focusing on a disaggregated analysis of consumption and RER. First, using region-level data for a large number of developed and developing economies we document the characteristics of the two puzzles in cross-country and within-country data. We then develop a combined model of inter-regional and international trade. The model exhibits variations in inter-regional as well as in inter-national consumption and real exchange rates. We show that with a combination of within country and across country shocks and endogenous non-tradability the model can rationalize the two puzzles, and does so in both international and intra-national dimensions.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1213.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1213

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  1. Kollmann, R., 1992. "Consumption, Real Exchange Rates and the Structure of International Asset Markets," Cahiers de recherche 9232, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  2. Kanda Naknoi, 2005. "Real exchange rate fluctuations, endogenous tradability and exchange rate regime," International Finance 0509004, EconWPA, revised 07 Nov 2005.
  3. Benigno, Gianluca & Thoenissen, Christoph, 2006. "Consumption and Real Exchange Rates with Incomplete Markets and Non-Traded Goods," CEPR Discussion Papers 5580, C.E.P.R. Discussion Papers.
  4. Vincent Labhard & Michael Sawicki, 2006. "International and intranational consumption risk sharing: the evidence for the United Kingdom and OECD," Bank of England working papers 302, Bank of England.
  5. Alok Johri & Amartya Lahiri, 2008. "Persistent Real Exchange Rates," Department of Economics Working Papers 2008-04, McMaster University.
  6. Ravn, Morten O., 2001. "Consumption Dynamics and Real Exchange Rate," CEPR Discussion Papers 2940, C.E.P.R. Discussion Papers.
  7. George Alessandria & Horag Choi, 2005. "Do sunk costs of exporting matter for net export dynamics?," Working Papers 05-20, Federal Reserve Bank of Philadelphia.
  8. Tesar, Linda L., 1993. "International risk-sharing and non-traded goods," Journal of International Economics, Elsevier, vol. 35(1-2), pages 69-89, August.
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