Euro Area Business Cycle Research Articles

Coherence of the business cycles of prospective members of the euro area and the euro area business cycle

Is it beneficial for Central and Eastern European EU Member States to join the euro area? To answer that question, the coherence of the business cycles of six EU Member States and the euro area is analyzed. These countries recently joined (Croatia) or are supposed to join the euro area in the (near) future. The analysis utilizes the synchronicity and similarity measures proposed by Mink et al. (2012). Whereas the synchronicity measure captures whether output gaps have the same sign, the similarity measure identifies differences in cycle amplitudes. It is observed that the business cycles of several countries, notably Romania and Hungary, are out of sync with that of the euro area. The output gap similarity and synchronicity measures for Croatia are also fairly low. However, this also holds for some countries in the euro area.

The Euro Area Business Cycle and its Drivers

The Euro Area Business Cycle and its Drivers

Dating the Euro Area Business Cycle: An Evaluation

In this paper we study the business cycle dating formulated by the CEPR committee for the euro area. We first compare recessions as defined by the CEPR to those obtained using alternative methodologies (e.g. Bry-Boschan algorithm) and we find that the CEPR dating is not fully in line with other dating rules that are based only on GDP dynamics, thus confirming that the committee considers a broader set of variables. We then evaluate the classification of economic activity in recessions and expansions; the underlying business cycle is either based on a single variable or estimated as a latent factor that captures the comovements of several macroeconomic series. We find that the CEPR chronology is more consistent with the estimated common factor than with what is implied by methods solely based on GDP. Finally, we analyze which real variables drive the classification of economic activity by the CEPR and we find that the properties of the CEPR chronology are mainly related to the dynamics of demand components, especially final consumption, and employment.

A multi-country dynamic factor model with stochastic volatility for euro area business cycle analysis.

This paper develops a dynamic factor model that uses euro area country‐specific information on output and inflation to estimate an area‐wide measure of the output gap. Our model assumes that output and inflation can be decomposed into country‐specific stochastic trends and a common cyclical component. Comovement in the trends is introduced by imposing a factor structure on the shocks to the latent states. We moreover introduce flexible stochastic volatility specifications to control for heteroscedasticity in the measurement errors and innovations to the latent states. Carefully specified shrinkage priors allow for pushing the model towards a homoscedastic specification, if supported by the data. Our measure of the output gap closely tracks other commonly adopted measures, with small differences in magnitudes and timing. To assess whether the model‐based output gap helps in forecasting inflation, we perform an out‐of‐sample forecasting exercise. The findings indicate that our approach yields superior inflation forecasts, both in terms of point and density predictions.

Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown in the Euro Area

This paper analyses the endogeneity of euro area total factor productivity and its role in business cycle amplification by estimating a medium-scale DSGE model with endogenous productivity mechanism on euro area data. In this framework, total factor productivity evolves endogenously as a consequence of costly investment in R&D and adoption of new technologies. We find that the endogeneity of TFP induces a high degree of persistence in the euro area business cycle via a feedback mechanism between overall economic conditions and investment in productivity-enhancing technologies. As to the sources of the euro area productivity slowdown, we conclude that a decrease in the efficiency of R&D investment is among the key factors generating the pre-crisis productivity slowdown, while starting from the Great Recession a shock to liquidity demand is identified as the most important driving force. The endogenous technology mechanism further exerts a dampening effect on the inflation response following a recessionary shock and hence has important implications for both the negligible fall in inflation during the Great Recession, as well as the sluggish increase of inflation in the subsequent recovery. JEL Classification: E24, E32, O31

Financial Drivers of the Euro Area Business Cycle: A Dsge-Based Approach

We estimate a modified version of the “Financial Business Cycles” model originally developed by Iacoviello (2015) in order to investigate the role played by financial factors in driving the business cycle in the euro area. In the model, financial shocks such as borrower defaults, collateral shocks and credit supply effects amplify economic downturns by reducing the flow of credit from banks to the real sector. In this novel application to the euro area, we introduce capital reallocation inefficiency, an innovation to the original set-up which allows for more realistic effects of entrepreneur defaults on economic activity. Our results suggest that financial factors, as captured by this model, played a smaller role in the euro area throughout the double-dip recession than in the United States during the 2008-09 global financial crisis. In a scenario on second-round effects implied by potential NFC loan losses due to the COVID-19 pandemic, we find large financial amplification risks to real economic activity.

Twenty Years of European Central Bank Monetary Policy: A Keynesian and Austrian Perspective

AbstractThis article reviews how the European Central Bank (ECB) implemented its monetary policy for the euro area from 1999 to 2018 from two perspectives. Taking a Keynesian point of view, the euro area economy was beset for a long time by secular stagnation and required the ECB to ensure a protracted period of relatively low interest rates to provide continuous support to aggregate demand at the level of the Economic and Monetary Union (EMU). By contrast, the Austrian School of Economics argues that the low-interest rate bias of the ECB caused financial excesses and prevented a more rapid reallocation of unviable resources necessary for a sustainable expansion of aggregate supply. Both the Keynesian and the Austrian paradigm appear relevant when examining the monetary and financial aspects of the euro area business cycle and the secular decline of interest rates over the past 20 years. For most of the time, ECB monetary policy was the ‘only game in town’ and the EMU architecture was unable to deliver the balanced macroeconomic and financial policy mix required for a sustainable path of the euro area economy.

Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown

This paper analyses the procyclicality of euro area total factor productivity and its role in business cycle amplification by estimating a medium-scale DSGE model with endogenous productivity mechanism on euro area data. Total factor productivity evolves endogenously as a consequence of costly investment in R&D and adoption of new technologies. We find that the endogeneity of TFP induces a high degree of persistence in the euro area business cycle via a feedback mechanism between overall economic conditions and investment in productivity-enhancing technologies. As to the sources of the euro area productivity slowdown, we conclude that a decrease in the efficiency of R&D investment is among the key factors generating the pre-crisis productivity slowdown, while starting from the Great Recession an increase in liquidity demand is identified as the most important driving force. The endogenous technology mechanism further exerts a dampening effect on the inflation response over the business cycle which helps rationalizing both the negligible fall in inflation during the Great Recession and the sluggish increase of inflation in the subsequent recovery.

Labor Productivity, Effort and the Euro Area Business Cycle

The Euro Area is characterized by little variation in unemployment and strongly procyclical labor productivity. We capture both characteristics in a New Keynesian business cycle model with labor search frictions, where labor can vary along three margins: employment, hours, and effort. We estimate the model with Bayesian methods and find evidence for a significant use of the effort margin in generating procyclical productivity. We show that a model with labor effort is more successful at matching the business cycle facts than is one with variable capital utilization or dominant technology shocks. Finally, we demonstrate that effort dampens the response of inflation to exogenous shocks.

A Euro Area Macroeconomic Stabilisation Function: Assessing Options in View of Their Redistribution and Stabilisation Properties

A macroeconomic stabilisation function for the euro area - as envisaged in the Five Presidents’ Report - plays a central role in the debate on deepening Economic and Monetary Union (EMU). We evaluate a broad range of options, their impact on economic growth, macroeconomic stabilisation and synchronisation of the euro area business cycle, and review how they could be designed so they do not undermine incentives for welfare-enhancing national economic policies. A common macroeconomic stabilisation function, e.g. in the form of a European Unemployment Insurance (EUI), could in theory help stabilise the business cycle in the euro area, especially in some participating Member States. Yet, simulating the effects of such a function for 2002-2014 suggests that its stabilisation properties would have been relatively limited. At the same time, design options with meaningful safeguards and relatively low financing requirements would have been most efficient when comparing the degree of stabilisation with the size of the funds distributed among countries. Finally, we discuss some design elements of a scheme whose aim is to support the transition process towards more resilient economic structures in the euro area as envisaged in the Five Presidents’ Report. JEL Classification: J65, H53, F55

Sentiment and Uncertainty Fluctuations and Their Effects on the Euro Area Business Cycle

This is paper considers the role of economic sentiment and economic uncertainty in explaining economic adjustment in the Euro area during the Financial Crisis and Great Recession. The analysis is based on VAR models of economic activity, sentiment and uncertainty in four sectors—industry, retail, services and construction. Evidence is found that sentiment and uncertainty have non-negligible effects on economic activity. Finally also some additional evidence is provided by studying the two largest Euro area countries: Germany and France.

Estimating Keynesian models of business fluctuations using Bayesian Maximum Likelihood

An empirical approach to model estimation and evaluation based on Bayesian Maximum Likelihood is introduced to the post-Keynesian literature. To illustrate the method, it is applied to a simple neo-Kaleckian model of euro area business cycle fluctuations including endogenous fiscal and monetary policy as well as endogenous wage formation. The estimated model parameters are broadly in line with the literature. To evaluate the empirical performance, we compare its marginal likelihoods and impulse-response functions to those of a corresponding Bayesian vector autoregression model after relaxing the theory-implied cross-coefficient restrictions as well as a benchmark dynamic stochastic general equilibrium model. The results suggest that both outperform the neo-Kaleckian model. In particular, we identify misspecification problems in the fiscal and monetary policy transmission mechanisms. Future research should be directed at improving the empirical fit of models in the post-Keynesian tradition and the current paper provides useful tools for doing so.

THE REGIME-SWITCHING VOLATILITY OF EURO AREA BUSINESS CYCLES

We document the strong evidence of time variation in the volatility of Euro Area business cycles since 1970. Then we provide the quantitative sources of these changes using a medium-scale DSGE model allowing time variation in structural disturbance variances. We show that (1) the size of different types of shock oscillates, in a synchronized manner, between two regimes over time, with the high-volatility regime prevailing predominantly in the 1970s, sporadically in the 1980s and 1990s, and during the Great Recession; (2) their relative importance remains, however, unchanged across regimes, where neutral technology shocks and marginal efficiency of investment shocks are the dominant sources of business cycle fluctuations; and 3) these investment shocks, which affect the transformation of savings into productive capital, can be interpreted as an indicator of credit conditions.

The US Dollar/Euro Exchange Rate: Structural Modeling and Forecasting During the Recent Financial Crises

The paper investigates the determinants of the US dollar/euro within the framework of the asset pricing theory of exchange rate determination, which posits that current exchange rate fluctuations are determined by the entire path of current and future revisions in expectations about fundamentals. In this perspective, we innovate by conditioning on Fama–French and Carhart risk factors, which directly measures changing market expectations about the economic outlook, on new financial condition indexes and macroeconomic variables. The macro‐finance augmented econometric model has a remarkable in‐sample and out‐of‐sample predictive ability, largely outperforming a standard autoregressive specification. We also document a stable relationship between the US dollar/euro Carhart momentum conditional correlation (CCW) and the euro area business cycle. CCW signals a progressive weakening in economic conditions since June 2014, consistent with the scattered recovery from the sovereign debt crisis and the new Greek solvency crisis exploded in late spring/early summer 2015. Copyright © 2016 John Wiley & Sons, Ltd.

The US$// Exchange Rate: Structural Modeling and Forecasting During the Recent Financial Crises

The paper investigates the determinants of the US$/€ exchange rate since its introduction in 1999, with a special focus on the recent subprime mortgage and sovereign debt financial crises. The econometric model is grounded on the asset pricing theory of exchange rate determination, which posits that current Exchange rate fluctuations are determined by the entire path of current and future revisions in expectations about fundamentals. In this perspective, we innovate the literature by conditioning on Fama-French and Charart risk factors, which directly measures changing market expectations about the economic outlook, as well as on new financial condition indexes and a large set of macroeconomic variables. The macro-finance augmented econometric model has a remarkable in-sample and out of sample predictive ability, largely outperforming a standard autoregressive specification neglecting macro-financial information. We also document a stable relationship between the US$/€-Charart momentum conditional correlation (CCW) and the euro area business cycle, potentially exploitable also within a system of early warning indicators of macro-financial imbalances. Comparison with available measures of economic sentiments shows that CCW yields a more accurate assessment, signaling a progressive weakening in euro area economic conditions since June 2014, consistent with the sluggish and scattered recovery from the sovereign debt crisis and the new Greek solvency crisis exploded in late spring/early summer 2015.

Euro Area Business Cycles in Turbulent Times: Convergence or Decoupling?

We study the business cycles properties of the four largest European economies in the wake of the recent recession episodes. The analysis is based on the factors estimated from a multi-country and multi-sector data rich environment. We measure alikeness of business cycles by studying the synchronization of up and down phases, the convergence properties of country fluctuations towards the Euro Area cycles and the contribution of the Euro Area factor to national GDPs volatilities. While the economic fluctuations of the four Euro Area member states were similar before the global financial turmoil, we gather compelling evidence of an asymmetric behavior of Spanish fluctuations relative to the Euro Area one.

Euro Area business cycles in turbulent times: convergence or decoupling?

We study the business cycle properties of the four largest European economies in the wake of the recent recession episodes. The analysis is based on the factors estimated from a multi-country and multi-sector data-rich environment. We measure alikeness of business cycles by studying the synchronization of up and down phases, the convergence properties of country fluctuations towards the Euro Area (EA) cycles and the contribution of the EA factor to national GDP volatilities. While the economic fluctuations of the four EA member states were similar before the global financial turmoil, we gather compelling evidence of an asymmetric behaviour of Spanish fluctuations relative to the EA one.

Euro Area Business Cycles in Turbulent Times: Convergence or Decoupling?

We study the business cycles properties of the four largest European economies in the wake of the recent recession episodes. The analysis is based on the factors estimated from a multi-country and multi-sector data rich environment. We measure alikeness of business cycles by studying the synchronization of up and down phases, the convergence properties of country fluctuations towards the Euro Area cycles and the contribution of the Euro Area factor to national GDPs volatilities. While the economic fluctuations of the four Euro Area member states were similar before the global financial turmoil, we gather compelling evidence of an asymmetric behavior of Spanish fluctuations relative to the Euro Area one.

Business cycle (de)synchronization in the aftermath of the global financial crisis: implications for the Euro area

AbstractThe introduction of Euro currency was a game-changing event intended to induce convergence of Eurozone business cycles on the basis of greater monetary and fiscal integration. The benefit of participating into a common currency area exceeds the cost of losing autonomy in national monetary policy only in case of cycle co-movement. However, synchronization was put back mainly due to country-specific differences and asymmetries in terms of trade and fiscal policies that became profound at the outset of the global financial crisis. As opposed to previous studies that are mostly based on linear correlation or causality modeling, we utilize the cross-wavelet coherence measure to detect and identify the scale-dependent time-varying (de)synchronization effects amongst Eurozone and the broad Euro area business cycles before and after the financial crisis. Our results suggest that the enforcement of an active monetary policy by the ECB during crisis periods could provide an effective stabilization instrument for the entire Euro area. However, as dynamic patterns in the lead-lag relationships of the European economies are revealed, (de)synchronization varies across different frequency bands and time horizons.

MODELLING LARGE OPEN ECONOMIES WITH INTERNATIONAL LINKAGES: THE USA AND EURO AREA

SUMMARYEmpirical modelling of the linkages between the euro area and the USA requires an open economy framework. The methodology proposed in this paper achieves identification of a structural vector error correction model by supplementing restrictions from economic theory with assumptions for the direction of causality in cross‐country contemporaneous relationships. Our baseline model assumes contemporaneous causality runs from the USA to the euro area for both output and inflation, with monetary policy domestically focused. The role of the USA as leading the euro area business cycle is reinforced by our results, but strong bidirectional cross‐country interactions are uncovered for inflation and interest rates. Copyright © 2013 John Wiley & Sons, Ltd.