DP5580 Consumption and Real Exchange Rates with Incomplete Markets and Non-Traded Goods

Author(s): Gianluca Benigno, Christoph Thoenissen
Publication Date: March 2006
Keyword(s): consumption-real exchange rate anomaly, incomplete financial markets, non-traded goods
JEL(s): F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5580

This paper addresses the consumption-real exchange rate anomaly. International real business cycle models based on complete financial markets predict a unitary correlation between the real exchange rate and the ratio of home to foreign consumption when subjected to supply side shocks. In the data, this correlation is usually small and often negative. This paper shows that this anomaly can be addressed by models that have an incomplete financial market structure and a non-traded as well as traded goods production sector.