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

  • Giancarlo Corsetti

    (Cambridge University, Rome III and CEPR)

  • Luca Dedola

    (European Central Bank and CEPR)

  • Francesca Viani

    (Banco de España)

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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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/12/Fich/dt1242e.pdf
File Function: First version, December 2012
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1242.

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Length: 68 pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:bde:wpaper:1242
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  1. Narayana R. Kocherlakota & Luigi Pistaferri, 2007. "Household Heterogeneity and Real Exchange Rates," Economic Journal, Royal Economic Society, vol. 117(519), pages C1-C25, 03.
  2. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2006. "Productivity, External Balance and Exchange Rates: Evidence on the Transmission Mechanism among G7 Countries," CEPR Discussion Papers 5853, C.E.P.R. Discussion Papers.
  3. Federico S. Mandelman & Pau Rabanal & Juan F. Rubio-Ramírez & Diego Vilán, 2010. "Investment-specific technology shocks and international business cycles: an empirical assessment," Working Paper 2010-03, Federal Reserve Bank of Atlanta.
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  8. 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.
  9. Corsetti, Giancarlo & Dedola, Luca, 2005. "A macroeconomic model of international price discrimination," Journal of International Economics, Elsevier, vol. 67(1), pages 129-155, September.
  10. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2014. "The International Dimension Of Productivity And Demand Shocks In The Us Economy," Journal of the European Economic Association, European Economic Association, vol. 12(1), pages 153-176, 02.
  11. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  12. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Working Papers 96-02, University of Washington, Department of Economics.
  13. 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.
  14. Christophe Croux & Mario Forni & Lucrezia Reichlin, 2001. "A measure of co-movement for economic variables: theory and empirics," ULB Institutional Repository 2013/10139, ULB -- Universite Libre de Bruxelles.
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  19. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers 1252, Queen's University, Department of Economics.
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  21. Hess, Gregory & Shin, Kwanho, 2006. "Understanding the Backus-Smith Puzzle: It’s the (Nominal) Exchange Rate, Stupid," MPRA Paper 696, University Library of Munich, Germany.
  22. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2008. "High exchange-rate volatility and low pass-through," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1113-1128, September.
  23. Deokwoo Nam & Jian Wang, 2010. "Understanding the effect of productivity changes on international relative prices: the role of news shocks," Globalization and Monetary Policy Institute Working Paper 61, Federal Reserve Bank of Dallas.
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