Business Cycle Co-movement and Trade Intensity in the Euro Area: is there a Dynamic Link?

Abstract

Summary This paper extends the recent literature that exclusively looks at the static link between bilateral trade intensity and business cycle synchronisation. A cross section augmented VAR framework with an unobservered common factor structure is used in order to apply the concept of Granger causality to test for dynamic links between variables. I conclude that although countries with intensive trade linkages also tend to have more similar business cycles in the long-run, the trade channel does not help to explain much of the short-run variation of business cycle co-movement in the euro area. The common factors have high predictive power for both business cycle co-movement and bilateral trade intensity. Thus, the paper provides evidence for the common shock view on business cycle synchronisation.