Merih Uctum, Brooklyn College and the Graduate Center, CUNY; Remzi Uctum, Universite de Paris Ouest; Chu-Ping C. Vijverberg, College of Staten Islands and the Graduate Center, CUNY
July 2017
Despite the recent resurgence in the European economies, the 2008 U.S. financial crisis that caused a global recession also pushed many of them, in particular, those in the periphery, into a stubborn recession, which led to the rise of populist political movements. The severity of the crisis is seen as an indictment of the European Monetary Union for failing to generate convergence to its members. Convergence is crucial for the conduct of the single monetary policy where members do not have recourse to fiscal transfer mechanisms nor currency adjustments. In this paper, we examine whether the process towards monetary union and the common experience of the euro, the single European currency, led to the convergence of output growth for member countries and if shocks to the economies affected it.
The skepticism about the promises of the European Monetary Union goes back to its conception, which occurred among intense controversy about whether the Eurozone was ready to become a currency union since it was not satisfying the original criteria of the Optimal Currency Area. Subsequent studies of currency unions showed a significantly deepened trade integration among member countries of a monetary union. The implication is that the Optimal Currency Area criteria can be satisfied after unification resulting in trade integration and income convergence. The endogenous business cycle synchronization argument draws on two linkages: If a currency union increases trade, which, in turn, leads to synchronization of business cycles, then it is argued that business cycles are synchronized “endogenously”. Empirical results are not uniform though several support the argument of increased synchronization through trade. However, these results are challenged by the view that business cycles in Europe are affected by many factors, which are mostly ignored except the trade channel but can decrease output co-movements in the union and their exclusion could lead to potentially biased results.
Convergence is a process that takes place over an extended period, disrupted by crises and recessions, speeding up during recovery and booms. The existing analyses that rely on panel methodologies are neither sufficiently long enough nor suitable to capture such non-linear processes. Our paper investigates output growth converge in the European Monetary Union from an angle different than the existing literature. We exploit the time series characteristics of several economies in the European Union and examine if output growth in the peripheral countries converged towards that of the core countries. The higher the elasticity of peripheral countries growth to that of core countries, the greater the synchronization between the core and the periphery. By using a novel methodology we are able to account for reverse causality and structural changes created by policy and crises, which are mostly ignored in the literature.
Therefore, the evidence we uncover does not support the view that the switch to euro would generate a closer integration of the markets and thus automatically synchronize growth rates between the peripherals and the core countries. However, our results support the view that the preparations towards the creation of the single currency spurred convergence among several countries in the region well before the introduction of the euro, and continued after that. Once the last ripple effects of the Great Recession subside, Europe should see a greater synchronization in the member economies, with possible beneficial impact on the political process.