CEEC-Eurozone: a convergence in business cycles

The paper argues that more convergence of business cycles will be needed in the enlarged eurozone.

The debate on the economic convergence of the CEECs with the EU is generally focused on the comparison of income levels (real convergence) and price levels (nominal convergence). However, there is a third aspect to convergence, that is, business cycles, which is also relevant to the admission of the CEECs to the Economic and Monetary Union. In order for the reaction of the monetary policy to be adapted to the whole enlarged area, a high degree of symmetry between the economic shocks undergone by the various countries is desirable. Such convergence can be observed through an increasing correlation in business cycles between the CEECs and the euro area.

Convergence of income does not imply, as such, any particular correlation in industrial cycles. Indeed, business cycle correlation has been observed relatively recently in a limited number of countries. The evolution of industrial production in the CEECs and in the euro area suggests an increasing correlation of the manufacturing cycle since 1993 in Hungary, Poland, the Czech Republic, Slovakia (known as the “Visegrad” countries) and Slovenia. However, there exist significant differences in individual trajectories : the Polish correlation with the European cycle has only appeared since 1997-1998, that of Hungary seems older and that of the Czech Republic more fragile. On the contrary, the evolution of the business cycle in the Baltic States is less connected to the European cycle, as the example of Estonia suggests.

This increasing correlation of cycles comes mainly via trade. Since the beginning of the 1990s, the CEECs’ rate of opening towards the UE has doubled. In 2001, exports to Germany represented between 26 and 40% of the total exports from the Visegrad countries and Slovenia. Foreign direct investment, according to whether they direct output towards intra-branch trade (rather favourable to this convergence) or towards inter-branch specialisation, theoretically have ambiguous effects.

The nature of the economic shocks, which are the source of these cyclical variations in activity, can be analysed more theoretically. Several recent studies also suggest that the supply and demand shocks which affect the GDP are not, for the majority of the CEECs, less correlated with those which affect the large countries of the euro area than those affecting the peripheral countries (Finland, Portugal, Greece, etc.). More specifically, Hungary shows a relatively high degree of business cycle correlation with France, Italy and Germany. This symmetry apparently exists, but to a lesser extent, in Estonia, Poland, Slovenia and the Czech Republic. Their adjustment to these shocks is reported to be, on the whole, slower than that of the European countries, but faster than that of Austria or Belgium for example. Finally, although the correlation of cycles has been increasing recently, it might be disturbed on a medium-term level by specific shocks like the reorganisation of the agricultural sector and the changing shopping basket resulting from an improvement in the standard of living.

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