Determinants of Business Cycle Synchronization: A Euro Area Context

Abstract

With the aim to promote economic integration on the European continent, the last step of the Economic and Monetary Union (EMU) was realized in 1999 through the establishment of the euro area. Rooted in the notion of an Optimum Currency Area (OCA), the relinquishment of national monetary policies called for the pursuit of business cycle synchronization amongst the member states. Four decades after this notion, the staticity of business cycle co-movement was, however, put into question through the proposition of shock transmitting determinants. To unveil the determinants, this thesis aims to examine the impact of trade, industrial dissimilarity and foreign direct investment (FDI) on business cycle synchronization in a euro area context between the years of 1999 and 2018. Three consecutive subperiods of 1999 to 2005, 2006 to 2012 and 2013 to 2018 are further included to allow for an examination of potential impact changes over time. Through the application of a two-stage least squares (2SLS) estimation technique, a disentanglement of the causal effects between business cycle synchronization and the determinants is made possible. The main results propose that increased trade and FDI contribute to co-movement while dissimilar industrial structures create asynchronous business cycles. Throughout the three investigated sub-periods, trade was identified to have a robust impact on co-movement and further remained the sole determinant in times of economic crises. The findings of this thesis accordingly contribute not only to academia yet also yield important policy implications for the future of a successful common monetary policy in the euro area.