Working Paper: NBER ID: w17288
Authors: Michael B. Devereux; Viktoria Hnatkovska
Abstract: A basic prediction of effcient risk-sharing is that relative consumption growth rates across countries or regions should be positively related to real exchange rate growth rates across the same areas. We investigate this hypothesis, employing a newly constructed multi-country and multi-regional data set. Within countries, we find signifcant evidence for risk sharing: episodes of high relative regional consumption growth are associated with regional real exchange rate depreciation. Across countries however, the association is reversed: relative consumption and real exchange rates are negatively correlated. We identify this failure of risk sharing as a border effect. We find that the border effect is substantially (but not fully) accounted for by nominal exchange rate variability. We then ask whether standard open economy macro models can explain these features of the data. We argue that they cannot. To explain the role of the nominal exchange rate in deviations from cross country consumption risk sharing, it is necessary to combine multiple sources of shocks, ex-ante price setting, and incomplete financial markets.
Keywords: real exchange rate; risk sharing; border effect; intranational economics
JEL Codes: F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| relative consumption growth (F62) | regional real exchange rate depreciation (F31) |
| relative consumption growth (F62) | real exchange rates (F31) |
| nominal exchange rate variability (F31) | consumption risk sharing (E21) |
| border effect (F55) | risk sharing (D16) |
| nominal exchange rate variability (F31) | border effect (F55) |