Working Paper: CEPR ID: DP7452
Authors: Robert Kollmann
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.
Keywords: consumption; hand-to-mouth consumers; limited asset market participation; real exchange rate
JEL Codes: F36; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hand-to-mouth households (D10) | consumption-real exchange rate anomaly (F31) |
| hand-to-mouth households (D10) | volatility in real exchange rate (F31) |
| hand-to-mouth households (D10) | volatility in net exports (F49) |
| hand-to-mouth households (D10) | price elasticity of relative world demand for domestic goods (D12) |
| price elasticity of relative world demand for domestic goods (D12) | negative correlation between relative consumption and real exchange rate (F31) |
| simultaneous shocks to output and investment (E22) | correlation between relative consumption and real exchange rate (F31) |