Endogenous fluctuations and international business cycles

McKnight, Stephen; Povoledo, Laura

Abstract

We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition to analyze the role of self-fulfilling expectations or beliefs in explaining international business cycles. We show that when self-fulfilling beliefs are correlated with technology shocks, the model can account for the counter-cyclical behavior 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 generate a positive correlation between the real exchange rate and relative consumption without a negative cross-country correlation for technology shocks, which is not supported by the data. We show that the inability to overcome the consumption-real exchange rate anomaly is common to a wide class of indeterminacy frameworks with an upward-sloping aggregate labor demand.

• Working Paper Type: Working Paper
• Publicly Available Date: Jun 7, 2019
• Peer Reviewed: Not Peer Reviewed
• Keywords: indeterminacy, self-fulfilling expectations, international business cycles, net exports, terms of trade, consumption-real exchange rate anomaly, combined impulse responses
• Public URL: https://uwe-repository.worktribe.com/output/853705