In economics, the Backus–Kehoe–Kydland consumption correlation puzzle, also known as the BKK puzzle, is the observation that consumption

Consumption (economics)

Consumption is a common concept in economics, and gives rise to derived concepts such as consumer debt. Generally, consumption is defined in part by comparison to production. But the precise definition can vary because different schools of economists define production quite differently...

 is much less correlated

Correlation

In statistics, dependence refers to any statistical relationship between two random variables or two sets of data. Correlation refers to any of a broad class of statistical relationships involving dependence....

 across countries than output

Output (economics)

Output in economics is the "quantity of goods or services produced in a given time period, by a firm, industry, or country," whether consumed or used for further production.The concept of national output is absolutely essential in the field of macroeconomics...

.

In an Arrow–Debreu economy, i.e. an economy with a complete set of state-contingent markets

Complete market

In economics, a complete market is one in which the complete set of possible gambles on future states-of-the-world can be constructed with existing assets without friction. Every agent is able to exchange every good, directly or indirectly, with every other agent without transaction costs...

, country-specific output risks should be pooled and domestic consumption growth should not depend heavily on country-specific income shocks. So according to theory we should observe that consumption is much more correlated across countries than output. What Backus, Kehoe and Kydland found in their article from 1992 was the opposite, namely that consumption is much less correlated across countries than output.

Backus, Kehoe, and Kydland (1992) calculate the correlation of HP-filtered consumption and output for 11 advanced countries relative to the US. The measured average consumption correlation was .19, whereas the average output correlation was .31. Obstfeld

Maurice Obstfeld

Maurice Moses "Maury" Obstfeld is a professor of economics at the University of California, Berkeley.He is well known for his work in international economics. He is among the most influential economists in the world according to IDEAS/RePEc....

 and Rogoff

Kenneth Rogoff

Kenneth Saul "Ken" Rogoff is currently the Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University. He is also a chess Grandmaster.-Early life:...

 (1996) reports average correlation of OECD countries with world consumption (35 “benchmark” countries) of .43, whereas the average OECD country’s output correlation with world benchmark is 0.52. The really puzzling part of these results is not that consumption levels are not perfectly correlated, but that they are less correlated than output. Apparently, there is hardly any risk sharing.

Obstfeld and Rogoff (2000) identifies this as one of the six major puzzles in international economics. The others are the home bias in trade puzzle

Home bias in trade puzzle

The Home bias in trade puzzle is a widely-discussed problem in macroeconomics and international finance, first documented by John T. McCallum in an article from 1995....

, the equity home bias puzzle

Equity home bias puzzle

The Equity home bias puzzle is the term given to describe the fact that individuals and institutions in most countries hold only modest amounts of foreign equity. This is puzzling since observed returns on national equity portfolios suggest substantial benefits from international diversification...

, the Feldstein-Horioka savings-investment correlations puzzle

Feldstein-Horioka puzzle

The Feldstein-Horioka puzzle is a widely-discussed problem in macroeconomics and international finance, first documented by Martin Feldstein and Charles Horioka in an 1980 paper. According to economic theory, if we assume that investors that are able to easily invest anywhere in the world, they ...

, the purchasing power and exchange rate disconnect puzzle, and the Baxter-Stockman neutrality of exchange rate regime puzzle. It is also related to the Backus-Smith consumption-real exchange rate puzzle

Backus-Smith puzzle

In economics, the Backus-Smith puzzle or consumption – real exchange rate anomaly is the observation that the correlations between consumption and real exchange rates are zero or negative. This is contrary to economic theory which predicts that with full risk sharing, relative consumption...

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Attempts to account for the perceived anomaly

Stockman and Tesar (1995) suggests two means of breaking the link between prices and quantities and making it hard for households to smooth consumption by trade. The first is nontraded goods: Suppose households like to consume goods that cannot be traded, like some services. If there is a positive technology shock raising their supply, they can’t smooth their consumption of these goods by exporting them abroad. The second is "taste shocks": If consumption rises in one country without any change in the economic environment, it will borrow abroad, driving up the interest rate and inducing the foreign country to cut back on its consumption. So consumption could be negatively correlated across countries.