Endogenous Fluctuations and International Business Cycles
41 Pages Posted: 30 Nov 2016 Last revised: 12 Mar 2021
Date Written: February 28, 21
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 find 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. The choice of the labor supply elasticity is shown to be critical for generating a negative correlation between the real exchange rate and relative consumption, thereby resolving the Backus-Smith puzzle.
Keywords: Indeterminacy; Sunspots and Self-Fulfilling Expectations; International Business Cycles; Net Exports; Terms of Trade; Consumption-Real Exchange Rate Anomaly; Combined Impulse Responses.
JEL Classification: E32, F41, F44
Suggested Citation: Suggested Citation