Working Paper: CEPR ID: DP5580
Authors: Gianluca Benigno; Christoph Thoenissen
Abstract: 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.
Keywords: consumption-real exchange rate anomaly; incomplete financial markets; nontraded goods
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| positive shock to traded goods sector (F41) | increase in home consumption relative to foreign consumption (D12) |
| positive shock to traded goods sector (F41) | appreciation of real exchange rate (F31) |
| increase in home consumption relative to foreign consumption (D12) | appreciation of real exchange rate (F31) |
| incomplete financial markets and nontraded goods (D52) | address consumption-real exchange rate anomaly (F31) |
| structure of disturbances and specification of preferences (D11) | determine overall cross-correlation between real exchange rates and relative consumption (F31) |