Macroeconomic policy coordination and the European business cycle: Accounting for model uncertainty and reverse causality

Abstract

This study established the relationship between macroeconomic policy coordination and business cycle synchronization, considering a dynamic panel framework that accounts for model uncertainty and reverse causality. The results show that uncoordinated fiscal policy is a source of idiosyncratic shocks, but coordinated monetary policy leads to business cycle divergence. Furthermore, ongoing monetary integration is going to be associated with lower business cycle synchronization. Establishing fiscal union can mitigate this effect by eliminating a source of asymmetric shocks associated with fiscal policy differences, and provide a substitute for independent monetary policy in the form of interregional transfers.