Business cycle synchronisation in EMU: Can fiscal policy bring member-countries closer?

Abstract

The present study adds to the literature on the impact of fiscal policy on business cycle synchronisation. Specifically, it investigates the effects of fiscal policy on business cycle synchronisation between the 10 EMU member-countries and the aggregate EMU12-wide business cycle, using a time-varying framework. The findings suggest that fiscal policy has important effects on business cycle synchronisation for all 10 EMU countries. Hence, fiscal policy is shown to have the potential to be supportive of macroeconomic stabilisation in the Eurozone. However the evidence reveals that none of the countries under examination consistently use fiscal policy to promote business cycle synchronisation.

Fiscal policy, government size and EMU business cycle synchronization

“…Put simply, these findings suggest that deviations in country‐specific fiscal policy stances tend to promote higher synchronization, which is in line with the policy prescription associated with OCA theory. Similar findings have also been shown by Degiannakis et al (). In contrast, Böwer and Guillemineau () find that fiscal policy differentials have driven differences between countries’ business cycles only prior to the establishment of the Stability and Growth Pact.…”

“…Dynamic business cycle synchronization (BCS ij,t ) can be approximated by the time‐varying correlation level between two countries’ cyclical components. Recent studies in this strand of the literature have shown that multivariate GARCH models, such as the Baba, Engle, Kraft and Kroner (BEKK) model of Engle and Kroner () are successful in capturing the time‐varying synchronization, as this is approximated by the dynamic correlations (see, Degiannakis et al, ; Degiannakis et al, ). Given the low frequency of our data, and the relatively small time period, we use a more parsimonious version of the BEKK model, namely the Diagonal BEKK (Diag‐BEKK) model, as used by Degiannakis et al ().…”

“…1 See, inter alia, Montinari and Stracca, (2016); Kappler and Sachs (2013); Cerqueira and Martins, (2009, 2011, (2009, 2011; Kose et al, (2008); Inklaar et al, (2008);de Haan et al, (2008); Calderon et al, (2007); Kose and Yi, (2006) ;Imbs, (2006); Camacho et al, (2006); Böwer and Guillemineau, (2006); Baxter and Kouparitsas (2005) ;Imbs, (2004); Morgan et al, (2004); Kose et al, (2003aKose et al, ( , (2003b; Kalemli-Ozcan et al, (2001); Frankel and Rose, (1998) ;Krugman, (1993); Canova and Dellas, (1993). Fourth, given that Degiannakis, Duffy, Filis, and Livada (2016) show the fiscal policy effects on business cycle synchronization are time varying, we also consider several sub-periods in our analysis. Changes in the determinants of business cycle synchronization during different phases of European integration can help in understanding why countries may have synchronous or asynchronous business cycles.…”

“…The technical details of the Diag-BEKK model can be found in Degiannakis et al (2016) and Xekalaki and Degiannakis (2010).…”

“…Fourth, given that Degiannakis, Duffy, Filis, and Livada () show the fiscal policy effects on business cycle synchronization are time varying, we also consider several sub‐periods in our analysis. Changes in the determinants of business cycle synchronization during different phases of European integration can help in understanding why countries may have synchronous or asynchronous business cycles.…”