Business Cycles Syncronaziation in Europe

Abstract

The European Union sets the premises for the appearance of a new phenomenon in the global economic setting: the synchronization of the national business cycles.

The aim of this article is to statistically prove the existence of a Euro are business cycle through the study of a classic indicator- the annual change of the GDP and also through the use of foreign trade indicators-the annual changes in exports in imports. Also, it is important, at the end, to choose the best of these indicators or a combination thereof to use as a benchmark for further studies.

The empiric study is useful to classify the European countries in clusters according to synchronization, a first step in adopting common policies.

Keywords

Business cycle, synchronization, Euro area, foreign trade.

1. INTRODUCTION

1.1. Preliminaries

Economic cycles belong to the history of modern economies with interdependent markets, free enterprises and private ownership of financial assets and capital goods. Business cycles have undergone a booming development in an era of significant growth of industry, banking and credit. They are varied and constantly changing, even if they retain the general characteristics of persistence and ubiquity, and specific regularities of amplitude and timing. All these aspects have been recognized by scholars and observers more attentive, concerned with the persistence of this issue.

For a long time there was considerable consensus among economists that business cycles are mainly endogenous fluctuations involving recurrent fluctuations of variables such as monetary and real prices and quantities, the expectations and achievements. Theories have agreed on a framework and distribution, but have contradicted mainly in terms of which factors are main and which ones have auxiliary roles.

Cycles had multiple causes and effects, they produced and solved own tensions and resources, nationally and internationally. Few have given a single driving factor, and few believed that it can be removed through a single, low-cost intervention in policy or institutional reform.

The macro organism of the European Union offers a fertile study ground for business cycles and, particularly for a specific phenomenon, their synchronization.

A regional union grounds its functionality in interdependence and collaboration between members. Close economic relations through a substantial period of time lead to the development of similarities between members.

Common economic policies of the EU, together with the adoption of a common currency in 1999 lead to an even tighter relation, resulting in a possible macro business cycle of the European Union to which each country is correlated up to a certain degree.

The aim of this article is to statistically prove the existence of a Euro are business cycle through the study of a classic indicator- the annual change of the GDP and also through the use of foreign trade indicators-the annual changes in exports in imports. Also, it is important, at the end, to choose the best of these indicators or a combination thereof to use as a benchmark for further studies.

1.2. Previous literature

Numerous academic studies have analyzed the phenomenon of business cycles synchronization in the European Union. Because of the common policies adopted in the union, some countries feel the disequilibrium effect generated by these political rules.

Is natural that some of these policies are borne in different ways and have different results for its members. For this reason we consider, both us and other economists who have studied the phenomenon that a better understanding of this mechanism will lead to better decision making and a more appropriate approach of member states.

This has been highlighted in the academic field, by several empirical Investigations: authors like Artis and Zhang [1] who found evidence that business cycles are becoming more synchronous across Europe.

With economic phenomenon of political harmonization, inside the European monetary union, the business cycles will start synchronizing. (Inklaar et al., 2007) [10].

Following the same idea, economic and monetary integration will stimulate foreign trade of a country, which in turn, will create the business cycles synchronization phenomena (Frankel and Rose)[8].

Instead, more sceptical economists like Kugman [11], [12] argue that economic integration will lead to regional concentration of economic activity. For this reason, sector specific shocks could become regional specific shocks, which increase the likelihood of asymmetric shocks and diverging business cycles. In conclusion we can say that the "pessimistic" vision of this phenomenon supports the idea that business cycles in the Euro area, especially at regional level, could get a divergent character in the future.

The following lines will perform a short sequence of economists who have focused on the analysis on the phenomenon of synchronization of business cycles in the European Union.

De Grauwe and Vanhaverbeke [6] have shown that exchange rates influence the regional flexibility of economies to adjust to exogenous shocks. Asymmetric shocks tend to occur with high frequency in a regional economic union.

Fatás [7] pointed out that cross-country regional correlation has increased whereas within the country area has decreased.

Clark and van Wincoop [5] made a parallel analysis of business cycles in the U.S. (regional) and inside the EU. They found that in the U.S. this phenomenon is more visible and much stronger than in Europe. Even if in the EU there is a currency unity, the border effect influences the development of the synchronization of business cycles in a monetary area.

Barrios et al. [2] have observed that there is a divergence between the cycles belonging to the Euro area and the UK.

Barrios and de Lucio [3] argue that the positive impact of regional economic integration leads to the phenomenon of correlation of business cycles. Relative economic size and industrial structure are the main determinants of business cycles in certain areas of the European Union.

Belk and Heine [4] have revealed that a decrease in unemployment is more synchronized in those areas of the EU where there is a similar structure of sector.

2. DATA AND METHOD

Business cycle synchronization is usually employed by using GDP and/ or industrial production. However, these variables do not account for trade and exchanges between countries that help regulate business cycles and, ultimately, lead to synchronization thereof. In this respect, it becomes natural to study the annual changes in imports and exports together with GDP changes.

Our empiric analysis is based on annul data over the period 1991-2011, for a sample of 27 countries from Europe, 23 members of the EU and 4 non-members, retrieved from World Bank database, together with aggregated data for the Euro area obtained from the same source.

The countries are divided into 5 groups: EU founding member states -Belgium, Deutschland, France, Italy, the Netherlands, United Kingdom, ”second wave” (1973-1995 adhering members)- Austria, Denmark, Finland, Greece, Portugal, Spain, Sweden, ”third wave” (2004 adhering members ) -Cyprus, Czech Republic, Hungary, Lithuania, Poland, Slovenia, Slovakia, ”forth wave” (2007 adhering members)- Bulgaria and Romania and non-EU states: Moldova Republic, Norway, Russia, Ukraine.

The study uses three variables, as defined by the World Bank methodology: GDP growth (annual %), Exports of goods and services (annual % growth), Imports of goods and services (annual % growth), in order to investigate both internal changes of the aggregate economy depicted by the GDP, and the bilateral trade and financial correlations between countries in Europe.

The selection of growth rates is motivated by the fact that the GDP, exports and imports are usually non-stationary series and are greatly influenced by the currency of the country, thus the exchange rates thereof. Growth rates are dimensionless, therefore suitable for cross-country comparison.

Nonetheless, these rates can exhibit a trend which is easily removed by the widely used Hodrick-Prescott filter, thus focusing on the deviation from the trend. The use of this filter is not affected by usual drawbacks because the analysis is purely historical and static and the domain closed.

The filter is obtained by minimizing the function:

illustration not visible in this excerpt

is a smoothing parameter, set as in the original paper at 1600.

The co-movements of the business cycles are measured by computing a Pearson correlation coefficient matrix of the filtered series for each variable.

This correlation coefficient is used to determine the relation between the three proposed indicator of the business cycle synchronization, namely: the GDP, exports and imports.

All the calculations and graphs were employed using EViwes7 and Microsoft Office Excel 2010 software packages.

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