Business cycle synchronization in the EMU: Core vs. periphery

This paper examines business cycle synchronization in the European monetary union (EMU) with a special focus on the core-periphery pattern in the aftermath of the crisis. For the European Central Bank (ECB), diverging economic trajectories represent a significant threat to the stability of the EMU, since the ECB can only react with a "one-size-fits-all" interest rate policy to stabilize output movements. In addition, business cycle synchronization is considered to be the most important optimum currency area (OCA) criterion. Apart from the synchronization of business cycles, we consider the amplitude of business cycle movements, because different amplitudes can lead to diverging cyclical conditions. Using a quarterly index for business cycle synchronization by Cerqueira (2013), our panel data estimates suggest that it is countries belonging to the core that are faced with increased synchronization among themselves after 2007Q4, whereas peripheral countries decreased synchronization with regards to the core, non-EMU countries and among themselves. Correlation coefficients and nonparametric local polynomial regressions corroborate these findings, but a high degree of correlation is not the only condition to ensure "one-size-fits-all". The usual focus on co-movements and correlations might be misleading, however, since we also find large differences in the amplitude of national cycles. We consider that countries which share the same business cycle might nevertheless experience quite different cyclical positions, and thus require a different monetary policy stance if the amplitude of the cycle is very different. We indeed find large differences in the amplitude of national cycles and the degree to which the national cycle reacts to the common one.