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
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: Suggested Citation