Wealth effects and countercyclical net exports

Abstract

Two-country, one-good business cycle models with Cobb–Douglas preferences predict procyclical net exports. The opposite is observed in the data. We show that introduction of preferences that eliminate wealth effects on labour supply remedies this discrepancy. It also improves the model's ability in matching cross-country correlations.

Keywords:

• wealth effects
• GHH preferences
• International Business Cycles

JEL Classification:

• E32
• F41
• G15

Notes

¹ For instance, Kehoe and Perri's (2002) model with endogenously incomplete markets accounts for international comovement but it predicts procyclical net exports. They refer to this property as ‘the main failing of the model’ (Kehoe and Perri, 2002, p. 926).

² Because their focus is different, Devereux et al. (1992) do not consider a fully calibrated business cycle model.

³ Given the values of and the steady-state capital–output ratio , we compute the discount factor as

⁴ Some of the mechanisms through which GHH preferences improve the model's predictions for international comovements is discussed by Devereux et al. (1992). However, they do not report simulations from a calibrated two-country model with correlated innovations to productivity.