List of Unsolved Problems in Economics - International Economics

International Economics

  • Home bias in trade puzzle: The home bias in trade puzzle is an empirical observation that even when factors such as economic size of trading partners and the distance between them are considered, trade between regions within a given country is substantially greater than trade between regions in different countries, even when there are no substantial legal barriers. There is currently no framework to explain this observation.
  • Equity home bias puzzle: This puzzle concerns the observation that individuals and institutions in many countries only hold modest amounts of foreign equity, despite the ability for vast diversification of their portfolios in the global economy. While some explanations do exist, such as that local individuals and firms have greater access to information about local firms and economic conditions, these explanations are not accepted by the majority of economists and have been mostly refuted.
  • Backus-Kehoe-Kydland puzzle: The Backus-Kehoe-Kydland consumption correlation puzzle is the empirical observation that consumption is much less correlated across countries than output. Standard economic theory suggests that country-specific output risks should be collective and domestic consumption growth should not depend strongly on country-specific income shocks. Thus, we should not see the observation that consumption is much less correlated across countries than output; and yet we do.
  • Feldstein-Horioka puzzle: The Feldstein-Horioka puzzle originates from an article in the 1980s that found that among OECD countries, averages of long-term national savings rates are highly correlated with similar averages of domestic investment rates. Standard economic theory suggests that in relatively open international financial markets, the savings of any country would flow to countries with the most productive investment opportunities; hence, saving rates and domestic investment rates would be uncorrelated, contrary to the empirical evidence suggested by Martin Feldstein and Charles Horioka. While numerous articles regarding the puzzle have been published, none of the explanations put forth have adequate empirical support.
  • PPP Puzzle: The PPP puzzle, considered one of the two real exchange rate puzzles, concerns the observation that real exchange rates are both more volatile and more persistent than most models would suggest. The only clear way to understand this volatility would be to assign substantial roles to monetary and financial shocks. However, if shocks play such a large role the challenge becomes finding what source, if one even exists, of nominal rigidity that could be so persistent to explain the long-term prolonged nature of real exchange rate deviations.
  • The Exchange Rate Disconnect Puzzle: The exchange rate disconnect puzzle, also one of the so-called real exchange rate puzzles, concerns the weak short-term feedback link between exchange rates and the rest of the economy. In most economies, the exchange rate is the most important relative price, so it is surprising, and thus far unexplained entirely, that the correlations are not stronger.

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