Non-separabilities due to home production break the link between market consumption and its marginal utility and help explain several stylized facts of the open economy. In an estimated two-country model with complete asset markets in which home production generates a labor wedge that mimics its empirical counterpart, output is more correlated than consumption across countries, labor inputs and labor wedges are positively correlated across countries, and relative market consumption is negatively related to the real exchange rate. Evidence from time use surveys corroborates some of the predictions of the model.
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Supplementary material associated with this article can be found at http://www.sciencedirect.com/science/journal/03043932 . This paper supersedes an earlier working paper under the title “Labor wedges and open economy puzzles.” For useful conversations and constructive comments, I thank Gianluca Benigno, Ariel Burstein, Yongsung Chang, Emmanuel Farhi, Gita Gopinath, Jonathan Heathcote, Chang-Tai Hsieh, Erik Hurst, Oleg Itskhoki, Ellen McGrattan, Jaromir Nosal, Fabrizio Perri, Andrea Raffo, Ricardo Reis, several anonymous referees, and seminar participants at Brandeis, Brown, Chicago Booth, Columbia GSB, Federal Reserve Bank of Minneapolis, Federal Reserve Board, Harvard, LSE, Penn State, Stockholm IIES, UC Berkeley, UCLA Anderson, and University of Iowa. I acknowledge summer financial support from Chicago Booth .
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- Home production
- International business cycles
- Labor wedge
- Real exchange rate