Business Cycle Synchronization and Regional Integration: A Case Study for Central America

Abstract

Deeper trade integration between Central America and the United States, as envisaged under the Central American free trade agreement, is likely to lead to closer links between Central American and U.S. business cycles. This article assesses the degree of business cycle synchronization between Central America and the United States-relevant not only for a better understanding of the influence of important trading partners on the business cycle fluctuations in the domestic economy but for evaluating the costs and benefits of macroeconomic coordination. If business cycles are similar and shocks are common, coordination of macroeconomic policies can become desirable, with a common currency as the ultimate form of policy coordination. But if shocks are predominately country-specific, resulting in little business cycle synchronization, independent monetary and fiscal policies are generally seen as important in helping an economy adjust to a new equilibrium. Clearly, if business cycles are affected predominately by country specific shocks and are likely to continue to be so, intensified macroeconomic coordination as part of regional integration might do more harm than good.