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The Consumption-Real Exchange Rate Anomaly: Non-Traded Goods, Incomplete Markets and Distribution Services

  • Jorge Selaive
  • Vicente Tuesta

The real exchange rate is volatile and tends to move in opposite direction with respect to relative consumption across countries. Chari, Kehoe and McGrattan (CKM, 2002) refer to the inability of models to replicate the last stylized fact as the consumption-real exchange rate anomaly. In this paper we show that an international RBC model similar to the one proposed by CKM but extended by considering nontraded goods and an incomplete asset market structure can solve this anomaly. Non tradable goods amplify wealth effects that arise from the incomplete assets market structure generating a negative comovement between the real exchange rate and relative consumption. The model performs reasonable well with other business cycle moments and, by adding distribution services in terms of nontraded goods, it generates a real exchange rate as volatile as in the data. Results are robust to the addition of nominal price rigidities and -in contrast with CKM- there is no need of monetary shocks to account for the real exchange rate dynamics.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 359.

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Date of creation: Apr 2006
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Handle: RePEc:chb:bcchwp:359
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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  2. Campa, Jose M. & Goldberg, Linda S., 2002. "Exchange rate pass-through into import prices: A macro or micro phenomenon?," IESE Research Papers D/475, IESE Business School.
  3. Ghironi, Fabio & Melitz, Marc, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," Scholarly Articles 3228377, Harvard University Department of Economics.
  4. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  5. Kollmann, Robert, 2002. "Monetary Policy Rules in the Open Economy: Effects on Welfare and Business Cycles," CEPR Discussion Papers 3279, C.E.P.R. Discussion Papers.
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  8. Betts, Caroline M. & Kehoe, Timothy J., 2006. "U.S. real exchange rate fluctuations and relative price fluctuations," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1297-1326, October.
  9. 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.
  10. Justiniano, Alejandro & Preston, Bruce, 2010. "Can structural small open-economy models account for the influence of foreign disturbances?," Journal of International Economics, Elsevier, vol. 81(1), pages 61-74, May.
  11. Vicente Tuesta & Pau Rabanal, 2006. "Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model; What is Important and What is Not," IMF Working Papers 06/177, International Monetary Fund.
  12. Irving B. Kravis & Robert E. Lipsey, 1986. "The Assessment of National Price Levels," NBER Working Papers 1912, National Bureau of Economic Research, Inc.
  13. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
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