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International and Intra-national Real Exchange Rates: Evidence and Theory

Viktoria Hnatkovska () and Michael Devereux ()

No 1213, 2009 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper we study two long-standing puzzles in the International Finance literature: the fact that the real exchange rate (RER) is very volatile (RER volatility puzzle) and that it covaries negatively with domestic consumption relative to foreign consumption (Backus-Smith puzzle). To understand the two puzzles we depart from the existing literature by focusing on a disaggregated analysis of consumption and RER. First, using region-level data for a large number of developed and developing economies we document the characteristics of the two puzzles in cross-country and within-country data. We then develop a combined model of inter-regional and international trade. The model exhibits variations in inter-regional as well as in inter-national consumption and real exchange rates. We show that with a combination of within country and across country shocks and endogenous non-tradability the model can rationalize the two puzzles, and does so in both international and intra-national dimensions.

Date: 2009
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed009:1213

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