Consumption and real exchange rates in dynamic economies with non-traded goods

Abstract

We examine the possibility that non-traded goods may account for several striking features of international macroeconomic data: large, persistent deviations from purchasing power parity, small correlations of aggregate consumption fluctuations across countries, and substantial international real interest rate differentials. A dynamic, exchange economy is used to show that non-traded goods in principle can account for each of these phenomena. In the theory there is a close relation between fluctuations in consumption ratios and those in bilateral real exchange rates, but we find little evidence for this relation in time-series data for eight OECD countries.