Dating Business Cycles: A Methodological Contribution with an Application to the Euro Area

This paper proposes a dating algorithm based on an appropriately defined Markov chain that enforces alternation of peaks and troughs, and duration constraints concerning the phases and the full cycle. The algorithm, which implements Harding and Pagan's non‐parametric dating methodology, allows an assessment of the uncertainty of the estimated turning points caused by filtering and can be used to construct indices of business cycle diffusion, aiming at assessing how widespread are cyclical movements throughout the economy. Its adaptation to the notion of a deviation cycle and the imposition of depth constraints are also discussed. We illustrate the algorithm with reference to the issue of dating the euro‐area business cycle and analysing its characteristics, both from the classical and the growth cycle perspectives.     

The Euro Effect on Trade is not as Large as Commonly Thought*

Existing studies on the impact of the euro on goods trade report increments between 5% and 40%. These estimates are based on standard panel gravity models for the level of trade. We show that the residuals from these models exhibit upward trends over time for the euro countries, and that this leads to an upward bias in the estimated euro effect. To correct for that, we extend the standard model by including a time trend that may have different effects across country‐pairs. This results in an estimated euro impact of only 3%.     

Measuring Synchronization and Convergence of Business Cycles for the Euro area,UK and US*

This paper investigates business cycle relations among different economies in the Euro area. Cyclical dynamics are explicitly modelled as part of a time series model. We introduce mechanisms that allow for increasing or diminishing phase shifts and for time‐varying association patterns in different cycles. Standard Kalman filter techniques are used to estimate the parameters simultaneously by maximum likelihood. The empirical illustrations are based on gross domestic product (GDP) series of seven European countries that are compared with the GDP series of the Euro area and that of the US. The original integrated time series are band‐pass filtered. We find that there is an increasing resemblance between the business cycle fluctuations of the European countries analysed and those of the Euro area, although with varying patterns.     

ALICE: Composite leading indicators for euro area inflation cycles

This paper develops Area-wide Leading Inflation CyclE (ALICE) indicators with the aim to provide early signals for turning points in the euro area headline and core inflation cycles. The headline (core) ALICE leads the reference cycle by three (four) months and the lead times extend to five (nine) months based on longer-leading series. Both ALICE indicators signalled turning points in the inflation cycles ex post and also performed well in a simulated real-time exercise. Moreover, in particular the headline ALICE also appeared to be useful for quantitative forecasting of the direction and level of inflation.     

The (de-)anchoring of inflation expectations: New evidence from the euro area

Well-anchored inflation expectations are a key factor for achieving economic stability. This paper provides new empirical results on the anchoring of long-term inflation expectations in the euro area. In line with earlier evidence, we find that euro area inflation expectations have been anchored until fall 2011. Since then, however, they respond significantly to macroeconomic news. Our results obtained from multiple endogenous break point tests suggest that euro area inflation expectations have remained de-anchored ever since.     

Econometric Evaluation of the New Keynesian Phillips Curve*

We give an appraisal of the New Keynesian Phillips curve (NPCM) as an empirical model of European inflation. The favourable evidence for NPCMs on euro‐area data reported in earlier studies is shown to depend on specific choices made about estimation methodology. The NPCM can be re‐interpreted as a highly restricted equilibrium correction model. We also report the outcome of tests based on variable addition and encompassing of existing models. The results show that economists should not accept the NPCM too readily.     

Combination schemes for turning point predictions

We propose new forecast combination schemes for predicting turning points of business cycles. The proposed combination schemes are based on the forecasting performances of a given set of models with the aim to provide better turning point predictions. In particular, we consider predictions generated by autoregressive (AR) and Markov-switching AR models, which are commonly used for business cycle analysis. In order to account for parameter uncertainty we consider a Bayesian approach for both estimation and prediction and compare, in terms of statistical accuracy, the individual models and the combined turning point predictions for the United States and the Euro area business cycles.     

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

Empirical 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.     

WILL BUSINESS CYCLES IN THE EURO AREA CONVERGE? A CRITICAL SURVEY OF EMPIRICAL RESEARCH

Abstract.  This survey of business cycle synchronization in the European monetary union focuses on two issues: have business cycles become more similar, and which factors drive business cycle synchronization. We conclude that business cycles in the euro area have gone through periods of both convergence and divergence. Still, there is quite some evidence that during the 1990s business cycle synchronization in the euro area has increased. Higher trade intensity is found to lead to more synchronization, but the point estimates vary widely. The evidence for other factors affecting business cycle synchronization is very mixed.     

TIME‐VARYING DYNAMICS OF THE REAL EXCHANGE RATE: AN EMPIRICAL ANALYSIS

We use a time‐varying structural vector autoregression to investigate evolving dynamics of the real exchange rate for the UK, euro area and Canada. We show that demand and nominal shocks have a substantially larger impact on the real exchange rate after the mid 1980s. Real exchange rate volatility, relative to fundamentals, also shows a marked increase after this point in time. However, there is some evidence suggesting a closer business cycle co‐movement of the real exchange rate and fundamentals. Simulations from an open‐economy DSGE model show that these results are consistent with a decline in exchange rate pass‐through. Copyright © 2012 John Wiley & Sons, Ltd.     

On the Real Effect of Financial Pressure: Evidence From Firm‐Level Employment During the Euro‐Area Crisis

Using a large panel of mainly unquoted euro‐area firms over the period 2003–2011, this paper examines the impact of financial pressure on firms’ employment. The analysis finds evidence that financial pressure negatively affects firms’ employment decisions. This effect is stronger during the euro area‐crisis (2010–2011), especially for firms in the periphery compared to their counterparts in non‐periphery European economies. When we introduce firm‐level heterogeneity, we show that financial pressure appears to be both statistically and quantitatively more important for bank‐dependent, small and privately held firms operating in periphery economies during the crisis.     

Money Growth and Inflation in the Euro Area: A Time‐Frequency View

This article provides new insights on the relationship between money growth and inflation in the euro area over the last 40 years. This highly relevant link for the European Central Bank monetary policy strategy is assessed using wavelet analysis. The findings indicate a stronger link between inflation and money growth at low frequencies over the whole sample period. At the typical business cycle frequency range the link is only present until the beginning of the 1980s. Moreover, there seems to be a recent deterioration of the leading properties of money growth with respect to inflation in the euro area.     

ARE THE CURRENT ACCOUNT IMBALANCES BETWEEN EMU COUNTRIES SUSTAINABLE? EVIDENCE FROM PARAMETRIC AND NON‐PARAMETRIC TESTS

Using parametric and non‐parametric estimation techniques, we analyze the sustainability of the recently growing current account imbalances in the euro area and test whether the European Monetary Union has aggravated these imbalances. Two alternative criteria for the assessment of external debt sustainability are considered: one based on the transversality condition of intertemporal optimization, and the other based on the stationarity properties of the stochastic process of the debt–GDP ratio. Econometric sustainability tests are performed using the pooled mean‐group estimator and panel unit root tests, respectively. Variants of both test procedures with varying coefficients using penalized splines estimation are applied. We find empirical evidence suggesting that the introduction of the euro is associated with a regime shift from sustainability to unsustainability of external debt accumulation for the euro area. Copyright © 2012 John Wiley & Sons, Ltd.     

Determinants of European stock market integration

We analyse the determinants of stock market integration among EU member states for the period 1999–2007. First, we apply bivariate DCC-MGARCH models to extract dynamic conditional correlations between European stock markets, which are then explained by interest rate spreads, exchange rate risk, market capitalisation, and business cycle synchronisation in a pooled OLS model. By grouping the countries into euro area countries, “old” EU member states outside the euro area, and new EU member states, we also evaluate the impact of euro introduction and the European unification process on stock market integration. We find a significant trend toward more stock market integration, which is enhanced by the size of relative and absolute market capitalisation and hindered by foreign exchange risk between old member states and the euro area. Interest rate spreads and business cycle synchronisation are also significant factors in explaining equity market integration.     

The time varying effect of oil price shocks on euro-area exports

In this paper we provide novel evidence on changes in the relationship between the real price of oil and real exports in the euro area. By combining robust predictions on the sign of the impulse responses obtained from a theoretical model with restrictions on the slope of the oil demand and oil supply curves, we identify oil supply and foreign productivity shocks in a time varying VAR with stochastic volatility. We find that from the 1980s onwards the relationship between oil prices and euro area exports has become less negative conditional on oil supply shortfalls and more positive conditional on foreign productivity shocks. Using the theoretical model we show that our empirical findings can be accounted for by (i) stronger trade relationship between the euro area and emerging economies (ii) a decrease in the share of oil in production and (iii) increased competitive pressures in the product market.     

COMPETITIVENESS WITHIN THE EURO AREA: THE PROBLEM THAT STILL NEEDS TO BE SOLVED

Unsustainable public debt, low competitiveness and high current account deficits are major problems for the so‐called PIIGS countries. These countries experienced consumer price and wage inflation above the euro area average in the first decade of the euro, basically fuelled by buoyant capital inflows. The resulting real appreciation against low‐inflation countries led to a deterioration in their competitiveness, but rigid labour markets now prevent a quick market‐based readjustment of real wages to the changed situation. Thus, both public expenditure cuts and structural labour market reforms are urgent to reduce the likelihood of a euro area break‐up.     

Testing for structural breaks in dynamic factor models

In this paper we investigate the consequences of structural breaks in the factor loadings for the specification and estimation of factor models based on principal components and suggest procedures for testing for structural breaks. It is shown that structural breaks severely inflate the number of factors identified by the usual information criteria. The hypothesis of a structural break is tested by using LR, LM and Wald statistics. The LM test (which performs best in our Monte Carlo simulations) is generalized to test for structural breaks in factor models where the break date is unknown and the common factors and idiosyncratic components are serially correlated. The proposed test procedures are applied to datasets from the US and the euro area.     

Supply,Factor Shares and Inflation Persistence: Re‐examining Euro‐area New‐Keynesian Phillips Curves*

Using euro‐area data, we re‐examine the empirical success of New‐Keynesian Phillips curves (NKPCs). We re‐estimate with a suitably specified optimizing supply side (which attempts to treat non‐stationarity in factor income shares and mark‐ups) that allows us to derive estimates of technology parameters, marginal costs and ‘price gaps’. Our resulting estimates of the euro‐area NKPCs are robust, provide reasonable estimates for fixed‐price durations and discount rates and embody plausible dynamic properties. Our method for identifying the underlying determinants of NKPCs has general applicability to a wide set of countries as well as of use for sectoral studies.     

Forecasting broad money velocity

This paper applies traditional approaches and mixed-data sampling (MIDAS) to explain and forecast velocity of broad money in the euro area and the United States. Our results show that despite financial innovations, over the last two decades broad money velocity followed a declining trend with one break around the start of the financial crisis in both economies. A new result is that applying mixed-frequency techniques, we find improvements in velocity forecasts for the euro area at all horizons considered (one to eight quarters ahead), whereas for the US possible gains only refer to shorter-term forecasts.     

Comovements and heterogeneity in the euro area analyzed in a non‐stationary dynamic factor model

This paper establishes stylized facts on comovements and heterogeneity of individual euro area countries' output and price developments in the past two decades. For this purpose, a non‐stationary structural dynamic factor model is fitted to a large dataset of euro area macroeconomic variables. The main results are as follows. Both common factors and idiosyncratic components are important in explaining individual countries' output and price developments in the euro area and are also both very persistent. Idiosyncratic shocks and adjustments to these shocks are mainly responsible for cross‐country heterogeneity. The asymmetric transmission of common shocks plays a minor role. Finally, there is no strong evidence that some common shocks lead to greater heterogeneity than others. Copyright © 2009 John Wiley & Sons, Ltd.