Can indeterminacy and self-fulfilling expectations solve the international macro puzzles?

McKnight, Stephen; Povoledo, Laura

Abstract

We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling expectations or beliefs can help resolve the major puzzles of international business cycles. We show that when self-fulfilling beliefs are correlated with technology shocks, the model can account for the counter-cyclical behaviour observed for the terms of trade and real net exports, while simultaneously generating higher volatilities relative to output, as in the data. However, the model cannot solve the Backus-Smith puzzle without a strongly negative cross-country correlation for technology shocks.

• Working Paper Type: Working Paper
• Deposit Date: Dec 15, 2016
• Publicly Available Date: Dec 15, 2016
• Peer Reviewed: Not Peer Reviewed
• Keywords: indeterminacy, self-fulfilling expectations, international business cycles, net exports, terms of trade, Backus-Smith puzzle
• Public URL: https://uwe-repository.worktribe.com/output/879490
• Contract Date: Dec 15, 2016