Trade and Exchange-Rate Dynamics in a Dynamic Competitive Economy
We apply recent advances in dynamic competitive analysis to open economy macroeconomics and draw out implications for comovement among consumption, output, trade balances, government deficits, and exchange rates. The real economy is a stochastic exchange model with complete markets. With time-separable preferences, cross-country risk-sharing implies perfect correlation between consumption in different countries, even when preference and endowments differ. With mild restrictions on the endowment process, this also implies a positive correlation between net exports and output in every country. With introduce money using a cash-in-advance constraint and show that any correlation between exchange rates and the balance of payments can be made consistent with the theory.
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