The International RBC Model Finally Works!

Speaker: A/Prof Suchant Acharya

Affiliation: University of Melbourne

Location: Room 101, Chamberlain Building (#35), St Lucia Campus

Zoom: https://uqz.zoom.us/j/89790507770

Abstract: We show that incorporating market incompleteness and countercyclical income risk can reconcile the predictions of an otherwise standard international real business cycle model with data. In particular, in addition to accounting for business cycle comovement, we analytically show that the model can account for (i) a low and negative correlation between relative consumption across countries and the real exchange rate (Backus-Smith puzzle), (ii) a correlation between consumption across countries, which is smaller than the correlation between output across the two countries (Backus-Kehoe-Kydland puzzle) and (iii) the fact that the domestic currency appreciates when domestic nominal interest rates exceed foreign interest rates (Fama puzzle). The model can also explain the difference between the business cycles in emerging versus developed economies such as a stronger countercyclicality of trade balances in emerging markets, and consumption volatility that exceeds output volatility.