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Robust control, informational frictions, and international consumption correlations

Yulei Luo (), Jun Nie () and Eric Young ()

No RWP 10-16, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In this paper we examine the effects of two types of information imperfections, robustness (RB) and nite information-processing capacity (called rational inattention or RI), on international consumption correlations in an otherwise standard small open economy model. We show that in the presence of capital mobility in nancial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to income shocks across countries facing different macroeconomic uncertainty. However, the calibrated RB model cannot explain the observed consumption correlations quantitatively. We then show that introducing RI is capable of matching the behavior of international consumption quantitatively via two channels: (1) the gradual response to income shocks that increases the correlations and (2) the presence of the common noise shocks that reduce the correlations.

Date: 2010
New Economics Papers: this item is included in nep-dge
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Related works:
Journal Article: Robust control, informational frictions, and international consumption correlations (2014) Downloads
Working Paper: Robust Control, Informational Frictions, and International Consumption Correlations (2013) Downloads
Working Paper: Robust Control, Informational Frictions, and International Consumption Correlations (2011) Downloads
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