Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/152742
Authors: 
Corsetti, Giancarlo
Dedola, Luca
Leduc, Sylvain
Year of Publication: 
2004
Series/Report no.: 
ECB Working Paper 308
Abstract: 
A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to effcient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that incomplete asset markets and a low price elasticity of tradables can account quantitatively for these properties of real exchange rates. The low price elasticity stems from distribution services, intensive in local inputs, which drive a wedge between producer and consumer prices and lower the impact of terms-of-trade changes on optimal agents’ decisions. Two very different patterns of the international transmission of productivity improvements generate the observed degree of risk-sharing: one associated with a strengthening, the other with a deterioration of the terms of trade and real exchange rate. Evidence on the effect of technology shocks to U.S. manufacturing, identified through long-run restrictions, is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements foster international risk-pooling.
Subjects: 
consumption-real exchange rate
distribution margin
incomplete asset markets
JEL: 
F32
F33
F41
Document Type: 
Working Paper

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