On demand shocks and international business cycle puzzles

- A stylized one-sector IRBC model is built to explain the comovement puzzle and the Backus-Smith puzzle.
- The model features complete asset markets and isoelastic additively separable preferences.
- The model solves both puzzles under demand shocks, but not under TFP shocks.
- The model explains a large set of domestic and international business cycle properties.

This note studies a parsimonious dynamic stochastic general equilibrium model driven by demand shocks to explain two central puzzles in open-economy macroeconomics: the comovement puzzle (Backus et al., 1992) and the Backus-Smith puzzle (Backus and Smith, 1993), while matching a large set of domestic and international business cycle properties observed in the industrialized countries. Features such as non-separable preferences, non-tradable sector, or market incompleteness do not appear to be preconditions for resolving these long-standing puzzles.