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International and Intra-national Real Exchange Rates: Evidence and Theory

  • Viktoria Hnatkovska

    (UBC)

  • Michael Devereux

    (UBC)

In this paper we study two long-standing puzzles in the International Finance literature: the fact that the real exchange rate (RER) is very volatile (RER volatility puzzle) and that it covaries negatively with domestic consumption relative to foreign consumption (Backus-Smith puzzle). To understand the two puzzles we depart from the existing literature by focusing on a disaggregated analysis of consumption and RER. First, using region-level data for a large number of developed and developing economies we document the characteristics of the two puzzles in cross-country and within-country data. We then develop a combined model of inter-regional and international trade. The model exhibits variations in inter-regional as well as in inter-national consumption and real exchange rates. We show that with a combination of within country and across country shocks and endogenous non-tradability the model can rationalize the two puzzles, and does so in both international and intra-national dimensions.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1213.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1213
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  1. 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.
  2. Gianluca Benigno & Christoph Theonissen, 2006. "Consumption and Real Exchange Rates with Incomplete Markets and Non-Traded Goods," CEP Discussion Papers dp0771, Centre for Economic Performance, LSE.
  3. George Alessandria & Horag Choi, 2007. "Do Sunk Costs of Exporting Matter for Net Export Dynamics?," The Quarterly Journal of Economics, MIT Press, vol. 122(1), pages 289-336, 02.
  4. Alok Johri & Amartya Lahiri, 2008. "Persistent Real Exchange Rates," Department of Economics Working Papers 2008-04, McMaster University.
  5. Tesar, Linda L., 1993. "International risk-sharing and non-traded goods," Journal of International Economics, Elsevier, vol. 35(1-2), pages 69-89, August.
  6. Ravn, Morten O, 2001. "Consumption Dynamics and Real Exchange Rate," CEPR Discussion Papers 2940, C.E.P.R. Discussion Papers.
  7. Kollmann, R., 1992. "Consumption, Real Exchange Rates and the Structure of International Asset Markets," Cahiers de recherche 9232, Universite de Montreal, Departement de sciences economiques.
  8. Naknoi, Kanda, 2008. "Real exchange rate fluctuations, endogenous tradability and exchange rate regimes," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 645-663, April.
  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. Vincent Labhard & Michael Sawicki, 2006. "International and intranational consumption risk sharing: the evidence for the United Kingdom and OECD," Bank of England working papers 302, Bank of England.
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