Can indeterminacy and self-fulfilling expectations help explain international business cycles? A preliminary investigation

McKnight, Stephen; Povoledo, Laura

Abstract

We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. We find that a combination of productivity and sunspot shocks can account for the observed counter-cyclical behavior in international relative prices and quantities, while simultaneously generating volatilities that match the data. The indeterminacy model can also resolve the Backus-Smith puzzle without requiring a low value of the trade elasticity.

• Working Paper Type: Working Paper
• Deposit Date: Dec 14, 2016
• Publicly Available Date: Dec 14, 2016
• Peer Reviewed: Not Peer Reviewed
• Keywords: indeterminacy, sunspots, international business cycles, net exports, terms of trade, real exchange rate, Backus-Smith puzzle
• Public URL: https://uwe-repository.worktribe.com/output/836910
• Publisher URL: http://www1.uwe.ac.uk/bl/research/bristoleconomicanalysis/economicsworkingpapers/economicspapers2016.aspx
• Contract Date: Dec 14, 2016