International business cycles: Information matters

We propose a mechanism that explains standard stylized facts in both international macroeconomics and finance. To do so, we develop New Keynesian DSGE model with financial frictions à la Bernanke et al. (1999), which depart from the full-information rational expectations (FIRE) assumption. The key ingredient is home information bias (HIB) expectations. While FIRE predicts high consumption co-movements, no departure uncovered interest parity (UIP) procyclical trade balance, assuming HIB makes consistent data by producing low correlation, solving quantity puzzle, generating endogenous departures UIP matching countercyclical balance. empirically validated shown to be robust extent of economy.