Can Indeterminacy and Self-Fulfilling Expectations Help Explain International Business Cycles? A Preliminary Investigation

31 Pages Posted: 9 May 2015 Last revised: 29 Nov 2016

See all articles by Stephen McKnight

Stephen McKnight

El Colegio de México

Laura Povoledo

University of the West of England - Bristol Business School

Date Written: March 31, 2015

Abstract

We introduce equilibrium indeterminacy into a two-country incomplete asset model with imperfect competition and analyze whether self-fulfilling, belief-driven fluctuations (i.e., sunspot shocks) can help resolve the major puzzles of international business cycles. We find that a combination of productivity and sunspot shocks can account for the observed counter-cyclical behavior in international relative prices and quantities, while simultaneously generating volatilities that match the data. The indeterminacy model can also resolve the Backus-Smith puzzle without requiring a low value of the trade elasticity.

Keywords: Indeterminacy, Sunspots, International Business Cycles, Net Exports, Terms of Trade, Real Exchange Rate, Backus-Smith Puzzle.

JEL Classification: E32, F41, F44

Suggested Citation

McKnight, Stephen and Povoledo, Laura, Can Indeterminacy and Self-Fulfilling Expectations Help Explain International Business Cycles? A Preliminary Investigation (March 31, 2015). Available at SSRN: https://ssrn.com/abstract=2603719 or http://dx.doi.org/10.2139/ssrn.2603719

Stephen McKnight

El Colegio de México ( email )

Camino al Ajusco 20,
Pedregal de Santa Teresa
México, D.F.
Mexico

Laura Povoledo (Contact Author)

University of the West of England - Bristol Business School ( email )

Frenchay Campus
Bristol, BS16 1QY
United Kingdom

HOME PAGE: http://www.povoledo.it

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