REALISTIC CROSS-COUNTRY CONSUMPTION CORRELATIONS IN A 2-COUNTRY, EQUILIBRIUM, BUSINESS-CYCLE MODEL

A well-known feature of one-good, multi-agent, Arrow-Debreu economies with identical, additively-separable, homothetic preferences is that the consumptions of all agents are perfectly correlated. Such economies are widely used in interpreting business cycles but seem to be inconsistent with observed cross-country correlations of aggregate consumption. This paper provides an example of a two-country real business cycle model in which preferences are not separable between consumption and labor supply. The model has a simple closed-form solution, and allows for fluctuations in labor supply in equilibrium. Moreover, it generates correlations between national consumption rates which are close to some of those observed in historical data.