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CEP discussion paper
Consumption and Real Exchange Rates with Incomplete Markets and Non-Traded Goods
Gianluca Benigno and Christoph Theonissen
December 2006
Paper No' CEPDP0771:
Full Paper (pdf)

JEL Classification: F31; F41

Tags: consumption-real exchange rate anomaly; incomplete financial markets; nontraded goods

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 non-traded as well as traded goods production sector.