Home Production, Labor Wedges, and International Real Business Cycles

This paper explores implications of non-separable preferences with home production for international business cycles. Home production induces substitution effects that 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. International time use surveys corroborate predictions of the model, showing a significant relationship between time spent on home production, labor wedges, and real exchange rates, both at business cycle frequencies and in the cross section of countries. By contrast, non-separabilities based on leisure do not help explain variations in labor wedges or real exchange rates.