Consumption and Real Exchange Rates in Professional Forecasts

Standard models of international risk sharing with complete asset markets predict a positive association between relative consumption growth and real exchange-rate depreciations across countries. The striking lack of evidence for this link — the consumption/ realexchange- rate anomaly or Backus-Smith puzzle — has prompted research on risk-sharing indicators with incomplete asset markets. That research generally implies that the association holds in forecasts, rather than realizations. Using professional forecasts for 28 countries for 1990-2008 we find no such association, thus deepening the puzzle. Independent evidence on the weak link between forecasts for consumption and real interest rates suggests that the presence of ‘hand-to-mouth’ consumers may help to explain the evidence.