Why Are Business Cycles Alike Across Exchange-Rate Regimes?

This poses a puzzle for standard international business cycle models. In this paper, the authors study this puzzle by developing a two-country, two-sector model with nominal rigidities featuring deviations from the law of one price because a fraction of firms set prices in buyers' currencies. The authors show that a model with such building blocks can improve the match between the model and the data across exchange-rate regimes. By partially insulating goods markets across countries and thus mitigating the international expenditure-switching effect, local currency pricing considerably dampens the responses of net exports to shocks hitting the economies therefore helping to account for the puzzle.