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The consumption-real exchange rate anomaly with extensive margins

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  • Masashige Hamano

    (CREA, Université du Luxembourg)

Abstract

This paper investigates a consumption-real exchange rate anomaly from the open macroeconomics literature known as the Backus-Smith puzzle . We both analytically and quantitatively examine how an expansion of trade along extensive margins can contribute to the puzzle's resolution. Our argument is based on 1) a wealth effect due to changes in the number of product varieties, 2) statistical inefficiency in measuring the number of product varieties, and 3) market incompleteness. Contrary to complete asset markets which, in general, feature overly strong risk sharing properties, changes in the number of product varieties under incomplete markets may produce a wealth effect under high trade elasticity. Since statistical agencies systematically fail to capture the welfare impact arising from that changes, data-consistent terms of trade and real exchange rates tend to appreciate due to this positive wealth effect. This provides a realistic correlation between data-consistent real exchange rates and consumption.

Suggested Citation

  • Masashige Hamano, 2013. "The consumption-real exchange rate anomaly with extensive margins," DEM Discussion Paper Series 13-01, Department of Economics at the University of Luxembourg.
    • Handle: RePEc:luc:wpaper:13-01
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    File URL: https://hdl.handle.net/10993/15266
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    Citations

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    Cited by:

    1. Masashige Hamano & Pierre M. Picard, 2017. "Extensive and intensive margins and exchange rate regimes," Canadian Journal of Economics, Canadian Economics Association, vol. 50(3), pages 804-837, August.
    2. Guglielmo Maria Caporale & Michael Donadelli & Alessia Varani, 2014. "International Capital Markets Structure, Preferences and Puzzles: The US-China Case," Discussion Papers of DIW Berlin 1362, DIW Berlin, German Institute for Economic Research.
    3. Hamano, Masashige, 2015. "International equity and bond positions in a DSGE model with variety risk in consumption," Journal of International Economics, Elsevier, vol. 96(1), pages 212-226.
    4. Nagayasu, Jun, 2017. "Inflation and consumption of nontradable goods: Global implications from regional analyses," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 478-491.
    5. Hamano, Masashige, 2022. "International risk sharing with heterogeneous firms," Journal of International Money and Finance, Elsevier, vol. 120(C).
    6. Caporale, Guglielmo Maria & Donadelli, Michael & Varani, Alessia, 2015. "International capital markets structure, preferences and puzzles: A “US–China World”," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 36(C), pages 85-99.
    7. Masashige Hamano & Pierre M. Picard, 2017. "Extensive and intensive margins and exchange rate regimes," Canadian Journal of Economics, Canadian Economics Association, vol. 50(3), pages 804-837, August.
    8. Jiang, Mingming, 2017. "On demand shocks and international business cycle puzzles," Economics Letters, Elsevier, vol. 160(C), pages 29-32.
    9. Masashige Hamano, 2017. "Missing Risk Sharing from International Transmission through Product Quality and Variety," DEM Discussion Paper Series 17-17, Department of Economics at the University of Luxembourg.

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    More about this item

    Keywords

    terms of trade; the Backus-Smith puzzle; firm entry;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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