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Demand shocks and open economy puzzles

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  • Jose-Victor Rios-Rull

    (University of Minnesota)

  • Yan Bai

    (University of Rochester)

Abstract

The paper explores to what extent demand shocks can solve the open economy puz- zles. To this purpose, we pose a shopping model structure a la Bai, R 퀱os-Rull, and Storesletten (2011) on top of an otherwise standard two-country international real busi- ness cycle model. Shopping for goods take effort, which prevents perfect matching between potential customers and producers. Larger demand in a country increases its consumption for both home and foreign goods. Real exchange rate and terms of trade depreciate in response to the larger demand. Larger demand also induces more shop- ping and so higher output and TFP. Thus, demand shock under our shopping model generates countercyclical terms of trade and solves the Backus-Smith puzzle.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 523.

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Date of creation: 2013
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Handle: RePEc:red:sed013:523

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  1. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
  2. Charles Engel & Jian Wang, 2008. "International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities," NBER Working Papers 13814, National Bureau of Economic Research, Inc.
  3. Loukas Karabarbounis, 2012. "Home Production, Labor Wedges, and International Real Business Cycles," NBER Working Papers 18366, National Bureau of Economic Research, Inc.
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