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Consumption and real exchange rates in professional forecasts

  • Michael B Devereux
  • Gregor W Smith
  • James Yetman

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/real-exchange-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.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 295.

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Length: 47 pages
Date of creation: Dec 2009
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Handle: RePEc:bis:biswps:295
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