Limited asset market participation and the consumption-real exchange rate anomaly

Authors


  • Other affiliations: Centre for Economic Policy Research (CEPR), London; Globalization and Monetary Policy Institute, Federal Reserve Bank of Dallas. I thank a referee for constructive comments. I also thank my conference discussants Parantap Basu, Simona Cociuba, Mick Devereux, Michael Evers, Viktor Tsyrennikov, and Werner Roeger for very helpful suggestions. Useful comments were also received from Giancarlo Corsetti, Mario Crucini, Gernot Müller, Dennis Novy, Paulo Santos Monteiro, Pedro Teles, Cédric Tille, and from workshop participants at EUI, IHEID (Geneva), Warwick, St Andrews, Bank of Greece, Konstanz Seminar, Federal Reserve Board, Dallas Fed, Econometric Society Winter meeting (Atlanta), and at the Bank of Canada-CEPR-ECARES conference, ‘International risk sharing’ (Brussels). I thank the National Bank of Belgium and the EU Commission for financial support. This paper is produced as part of the CEPR project ‘Politics, economics and global governance: the European dimensions,’ funded by the European Commission under its 7th Framework Programme for Research (Collaborative Project) Contract No. 217559. Email: robert_kollmann@yahoo.com

Abstract

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. This paper shows 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 behaviour also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

Abstract

S’il y avait un partage efficace du risque, tel que supposé dans des modèles standard du cycle des affaires international, alors la consommation agrégée d’un pays augmenterait, par rapport à la consommation étrangère, lorsque le taux de change réel du pays se déprécie. Cependant, empiriquement, la corrélation entre la consommation relative et le taux de change réel est proche de zéro. Cette étude montre que ce phénomène peut être expliqué par un modèle simple dans lequel une partie des ménages a accès à des marchés financiers complets, tandis que les ménages restants ‘vivent au jour le jour’ (VJJ). Un comportement VJJ engendre aussi une volatilité plus élevée du taux de change réel et des exportations nettes, ce qui accroît également la pertinence empirique du modèle.

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