Discussion Paper Details

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Title: Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly

Author(s): Robert Kollmann

Publication Date: September 2009

Keyword(s): consumption, hand to mouth consumers, limited asset market participation and real exchange rate

Programme Area(s): International Macroeconomics

Abstract: Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country?s aggregate consumption rises relative to foreign consumption, when the country?s real exchange rate depreciates. Yet, empirically, relative consumption and the real exchange rate are essentially uncorrelated. I show that this ?consumption-real exchange rate anomaly? can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behavior also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

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Bibliographic Reference

Kollmann, R. 2009. 'Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly'. London, Centre for Economic Policy Research.