On the consumption-real exchange rate anomaly

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 01 March 2005

Working Paper No. 254
By Gianluca Benigno and Christoph Thoenissen

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 successfully addressed by models that have an incomplete financial market structure and a nonñtraded as well as traded goods production sector.

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