^*Charles Engel is a Professor of Economics at the Department of Economics at the University of Wisconsin. John H. Rogers is Deputy Associate Director of the International Finance Division of the Board of Governors of the Federal Reserve System. The authors thank Ben Chiquoine for outstanding research assistance and Andrea Ferrero and Robert Kollmann for comments.

Abstract

Survey data show that the expected growth rates of consumption across countries vary widely and are not highly correlated. This data contradict the simplest of open-economy models in which there is a freely traded non-state-contingent bond and purchasing power parity holds. This paper explores two alternative explanations for the finding: that households in each country in effect face different ex ante real interest rates or that there are significant credit constraints, so that expected consumption growth rates are driven largely by expected income growth. The empirical evidence strongly supports the latter hypothesis. These findings challenge the modeling of consumption that is at the heart of many, if not most, macroeconomic models.