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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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File URL: https://economicdynamics.org/meetpapers/2009/paper_1213.pdf
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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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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. George Alessandria & Horag Choi, 2005. "Do sunk costs of exporting matter for net export dynamics?," Working Papers 05-20, Federal Reserve Bank of Philadelphia.
  2. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2003. "International risk-sharing and the transmission of productivity shocks," Working Papers 03-19, Federal Reserve Bank of Philadelphia.
  3. Giancarlo Corsetti & Philippe Martin & Paolo Pesenti, 2008. "Varieties and the Transfer Problem: The Extensive Margin of Current Account Adjustment," NBER Working Papers 13795, National Bureau of Economic Research, Inc.
  4. Bergin, Paul R. & Glick, Reuven & Taylor, Alan M., 2006. "Productivity, tradability, and the long-run price puzzle," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2041-2066, November.
  5. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
  6. Bent E. S�rensen & Oved Yosha, 1998. "International Risk Sharing and European Monetary Unification," Temi di discussione (Economic working papers) 327, Bank of Italy, Economic Research and International Relations Area.
  7. Tesar, Linda L., 1993. "International risk-sharing and non-traded goods," Journal of International Economics, Elsevier, vol. 35(1-2), pages 69-89, August.
  8. Ravn, Morten O, 2001. "Consumption Dynamics and Real Exchange Rate," CEPR Discussion Papers 2940, C.E.P.R. Discussion Papers.
  9. Sorensen, B-E & Yosha, O, 1996. "International Risk Sharing and European Monetary Unification," Papers 40-96, Tel Aviv.
  10. 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.
  11. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
  12. Amartya Lahiri & Kei-Mu Yi, 2009. "A Tale of Two States: Maharashtra and West Bengal," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 523-542, July.
  13. Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
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