Business Cycle Synchronization in Europe: Evidence from a Dynamic Factor Model

This paper revisits the effect of the European Economic and Monetary Union (EMU) on the extent of business cycle synchronization across its member states. A dynamic latent factor model is used to identify the ‘regional’ effect of the euro area on output growth and inflation dynamics across European countries. The results of variance decomposition analysis confirm that both output growth and inflation tended to be more synchronized among European countries during the run-up to the EMU, but there is no strong evidence to support the argument that the ‘regional’ effects prevailed after 1999.