Macroeconomic Synchronization and Policy Coordination After Regional Economic Integration in the Americas

Abstract

In spite of many significant differences between high-income and developing country partners in the North American Free Trade Agreement (NAFTA), business cycle synchronization has followed increased trade integration in the post-NAFTA period. There is also some preliminary support for some convergence between Dominican Republic-Central American Free Trade Agreement (CAFTA-DR) economies post-CAFTA-DR, although it is too soon to reach any significant conclusions. Macroeconomic synchronization has important implications for policy making because it indicates the need for and benefits from policy coordination. Policy coordination with high-income partners may benefit developing country partners by reducing macroeconomic volatility and increase stability, when macroeconomic variability is due to common shocks and not country-specific shocks. Idiosyncratic volatility would require monetary and fiscal policy autonomy rather than coordination. Examining policy coordination between NAFTA states and between CAFTA-DR members, I find little evidence for policy coordination before and after implementation of the FTA. For the developing partners in NAFTA and CAFTA-DR, even as trade integration shrinks the available policy options for member states, the costs of losing policy autonomy largely outweigh the benefits of coordination because of the idiosyncratic macroeconomic variability of the developing partners.