The consumption-real exchange rate anomaly with extensive margins

Masashige Hamano

Journal of International Money and Finance, 2013, vol. 36, issue C, 26-46

Abstract: This paper investigates a consumption-real exchange rate anomaly from the open macroeconomics literature known as the Backus-Smith puzzle. We both analytically and quantitatively examine how an expansion of trade along extensive margins can contribute to the puzzle's resolution. Our argument is based on 1) a wealth effect due to changes in the number of product varieties, 2) statistical inefficiency in measuring the number of product varieties, and 3) market incompleteness. Contrary to complete asset markets which, in general, feature overly strong risk sharing properties, changes in the number of product varieties under incomplete markets may produce a wealth effect under high trade elasticity. Since statistical agencies systematically fail to capture the welfare impact arising from that changes, data-consistent terms of trade and real exchange rates tend to appreciate due to this positive wealth effect. This provides a realistic correlation between data-consistent real exchange rates and consumption.

Keywords: Terms of trade; The Backus-Smith puzzle; Firm entry (search for similar items in EconPapers)
JEL-codes: F12 F41 F43 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Working Paper: The consumption-real exchange rate anomaly with extensive margins (2013)
Working Paper: The consumption-real exchange rate anomaly with extensive margin (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:36:y:2013:i:c:p:26-46

DOI: 10.1016/j.jimonfin.2013.03.001

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