DP7452 Limited Asset Market Participation and the Consumption-Real Exchange Rate Anomaly
|Publication Date:||September 2009|
|Keyword(s):||consumption, hand to mouth consumers, limited asset market participation, real exchange rate|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=7452|
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.