International Risk Sharing and Land Dynamics

While business cycles of industrialized countries have become more synchronized in the past decade, the gap between cross-country correlations in output and in consumption, known as the quantity anomaly, has widened on average. A two-country real business cycle model with national endogenous borrowing constraints and frictionless international financial markets can account for these stylized facts that are related to international risk sharing. When preferences are non-separable between consumption and leisure, the borrowing mechanism brings about an internal labor wedge that interacts with the efficient international allocation. This labor wedge is also fundamental to explain the Backus-Smith puzzle or consumption—real-exchange-rate anomaly. Technology shocks contribute to explain international co-movements, whereas country-specific financial shocks to borrowing capacity allow the model to replicate the lack of international risk sharing. When the model is augmented with an additional sector, real estate, international co-movements are matched more closely.