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Can indeterminacy and self-fulfilling expectations help explain international business cycles?

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Listed:
  • Stephen McKnight

    (El Colegio de México)

  • Laura Povoledo

    (University of the West of England, Bristol)

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.

Suggested Citation

  • Stephen McKnight & Laura Povoledo, 2015. "Can indeterminacy and self-fulfilling expectations help explain international business cycles?," Working Papers 20151504, Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol.
    • Handle: RePEc:uwe:wpaper:20151504
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    More about this item

    Keywords

    Indeterminacy; Sunspots; International Business Cycles; Net Exports; Terms of Trade; Real Exchange Rate; Backus-Smith Puzzle;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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