How Synchronized are New EU Member States with the Euro Area? Evidence from a Structural Factor Model

Abstract

A high degree of cyclical synchronization between the new EU member states (NMS) from central and eastern Europe and the euro area is generally seen as a prerequisite for successful EMU enlargement. This paper investigates comovements between NMS and the euro area. We first establish stylized facts on economic linkages using dynamic correlation and cohesion measures. We then identify the main structural common euro-area shocks and investigate their transmission to the NMS in comparison to the current EMU members by means of a large-scale dynamic factor model. Overall, our results are mixed. Dynamic business cycle and inflation correlations between NMS and the euro area are, on average, lower than between individual EMU members and the euro area, but they are higher than for some small peripheral EMU countries. This is confirmed by our other measure, variance shares of output and inflation explained by common euro-area factors. The proliferation of euro-area shocks to the NMS does not differ significantly from the propagation to EMU countries in most cases. There seems to be considerable heterogeneity across NMS, implying that for some countries, accession to EMU would be more costly than for others. According to our analysis and based on our measures, Poland, Slovenia, Hungary and Estonia are more suitable EMU candidates than other countries.