The construction of European Monetary Union has raised several questions about the existence of a common business cycle, a European one. The lack of cyclical synchronization would complicate the monetary and fiscal policies in the Union, being a negativeEuropean business cycle, correlation, synchronization of business cycles

Ifrim Mihaela

Ignat Ion

English

Research Papers in Economics

332 
 
THE EUROPEAN BUSINESS CYCLE 
 
Ifrim Mihaela 
„Alexandru Ioan Cuza” University Faculty of Economics and Business Administration Carol I 
Boulevard no.22, building B, room B383C, Ia i, Romania Email: mihaifrim@yahoo.com Phone: 
0745 324 347 
Ignat Ion  
„Alexandru Ioan Cuza” University Faculty of Economics and Business Administration Carol I 
Boulevard no.22, building B, room B423, Ia i, Romania Email: ignation@uaic.ro Phone: 0744 
623 462 
 
The  construction  of  European  Monetary  Union  has  raised  several  questions  about  the  existence  of  a 
common  business  cycle,  a  European  one.  The  lack  of  cyclical  synchronization  would  complicate  the 
monetary and fiscal policies in the Union, being a negative factor as regards the fulfilling of the necessary 
conditions for the existence of an optimal currency area. Like so many other economic issues, there is not a 
unanimously  agreed  verdict  on  this  matter  either.  Thus,  some  authors  sustain  the  asymmetry  and 
heterogeneity of European business cycles and the existence of national cycle "clusters”, while others 
identify a number of similarities that determined them to promote the idea of a single European cycle. 
 
Keywords: European business cycle, correlation, synchronization of business cycles  
 
JEL classification: E32 
 
Introduction 
One of the major concerns of the European monetary policy decision makers is the economic 
differences between the euro area member countries. This is because a common monetary policy 
cannot be effective for countries being in different phases of the business cycle. So, we can 
identify at European level a "one size does not fit all" problem, which could threat the support for 
the  European  Monetary  Union.  The  country  being  in  recession  will  prefer  an  expansionary 
monetary policy, while the country experiencing a boom would prefer some more restrictive 
measures. This problem would disappear if we could speak about the existence of a common 
business cycle, a European one, with a high degree of different cyclical stages synchronization 
between countries. Accelerating the integration process was sometimes motivated by the need to 
eliminate the disparities between European countries, resulting in a closer economic correlation. 
However, a more pessimistic vision believes that integration will mean a stronger trend toward 
industrial specialization and regional concentration of similar industries as a result of pursuing 
the economies of scale. Thus, the industrial shocks will turn into regional shocks and the business 
cycles of the European countries will become even more divergent. In this context, our aims are 
to identify some characteristics of the European business cycle, the correlations between different 
European countries’ cyclical movement and the factors responsible for their synchronization or 
non synchronization.  
 
Chronology of the European business cycles 
The tradition of a national forum responsible for dating the business cycles in the United States 
resulted in creating a similar institution within the European Union. Thus, in 2003, The Center 
for Economic Policy Research (CEPR) has established a committee whose mission has become 
to complete a chronology of expansions and recessions in the euro area since 1970. To achieve 
this chronology CEPR used the principles established by NBER (National Bureau of Economic 
Research), but  different primary  data used and the quarterly, not monthly  analysis made the 333 
 
results not be the same as those of Americans. According to CEPR
206, cyclical episodes in the 
euro area between 70-'90, were: 
 
Table 1. Chronology of euro area business cycles 
TROUGH  PEAK 
1974 3
rd quarter  1975 1
st quarter 
1980 1
st quarter   1982 3
rd quarter 
1992 1
st quarter  1993 3
rd quarter 
 
Thus, the Committee identified three recessions in the euro area for the period examined, from 
the third quarter of the year 1974 to the first quarter of 1975, from the first quarter of 1980 to the 
third quarter of 1982 and from the first quarter of 1992 to the third quarter of 1993. According to 
CEPR, the recessions of 70s and 90s were more pronounced and also synchronized between 
countries.  In  both  periods,  employment,  investment and  industrial  output fell along  with  the 
Gross  Domestic  Product.  In  the  80s,  the  recession  is  moderate,  but  longer.  Gross  Domestic 
Product  does  not  have  a  pronounced  decline,  but  rather  a  stagnation,  but  employment  and 
investment decline to a greater extent. Starting with the first quarter of 2001, GDP of the euro 
area experienced a contraction, for the beginning of 2002 to see a slight resurgence. Employment 
has increased somewhat, but industrial production has given weak signs of recovery. However, 
this period is considered rather a prolonged pause in the growth of economic activity, rather than 
a full-fledged recession. CEPR announced on 31 March 2009 that economic activity in the euro 
area reached its peak in the first quarter of 2008. The peak marked the end of an expansion that 
began in the third quarter of 1993 and lasted 57 quarters.  
Even if these data are based on the overall evolution of aggregate GDP in the euro area and the 
evolution of industrial production, the periods of peak and trough are not common for all the 
European countries. The issue of synchronizing the business cycles of the euro countries calls 
into question the very idea of an optimal currency area through the inefficiency of applying a 
common monetary policy. Different responses to external shocks or the existence of different 
internal shocks seriously put into question the existence of a border line effect regarding the 
European cyclical correlation. 
 
Business Cycle correlation  
Various  studies  on  the  correlation  of  business  cycles  in  European  countries  have  reached 
different results. Thus, Artis and Zhang
207 argue in 1999 the existence of a better European cycle 
synchronization, while in 2001 Inklaar and De Haan
208 reach the conclusion that the periods of 
cyclical convergence are alternated with those of divergence, this being a defining feature of the 
euro area.. These results contrast with the vision that the deepening of European integration will 
mean a better synchronization of business cycles. 
To support a theory or another, Massmann and Mitchell conducted in 2004 a study based on 
European  industrial  production  for  the  past  40  years  using  several  methods  of  mathematical 
modeling  and  performing  correlation  between  the  first  12  countries  of  the  euro  area.  The 
                                                       
206 Business Cycle Dating Committee of the Centre for Economic Policy Research;  
http://www.cepr.org/press/dating.pdf . 
207 Michael Artis; Wenda Zhang; “Further Evidence on The International Business Cycle and the ERM: Is 
There a European Business Cycle?”; Oxford Economic Papers; no.51; 1999. 
208 Robert Inklaar; Jakob de Haan; “ Is There Really a European Business Cycle?” Oxford Economic 
Papers no. 53; 2001. 334 
 
conclusion reached by these authors is the coexistence of convergence and divergence periods. 
On average, the correlation coefficient between the European business cycles is positive and 
high, but its dominant feature is a strong volatility. Thus, in the second half of the 70s the cycle 
correlation coefficient amounted to 0.8, for the second half of the 80s to fall close to 0. 
A  similar  analysis  on  pairs  of  countries  is  made  by  Uwe  Bower  and  Catherine 
Guillemineau
209.  According  to  their  study,  the  highest  coefficient  of  business  cycle 
correlation,  of  0.85,  was  obtained  by  the  pair  of  states  Belgium-Italy.  Fairly  high 
correlations  were  observed  for  the  pairs  Spain-Portugal,  Belgium-France,  Germany-
Austria  or  Germany-Holland.  The  weakest  correlations  were  obtained  between  states 
situated at large geographical distances, although this is not always true. For example, a 
negative correlation existed between Germany and Finland, affected asymmetrically by 
the same external shock, the collapse of communism in Europe. The unified Germany was 
experiencing  a  boom  of  the  business  cycle  when  Finland  was  already  in  recession 
following the collapse of the Soviet Union, one of its main trading partners. Overall, the 
lowest correlation was obtained in the period 1981-1988, with a coefficient of 0.18 and 
the highest during the years 1993-2000, with a coefficient of 0.73. The year 1997 seems to 
be an important benchmark as regards the better business cycles correlation of the EMU 
countries, then being signed the Stability and Growth Pact and fixed the implementation 
timetable of the common European monetary policy. 
M. Camacho, G. Perez-Quiros and L. Saiz
210 talk about the existence of clusters formed by states 
that have experienced cyclical fluctuations closed as time and amplitude. They extend the study 
to all EU states, even if they are not yet part of EMU. A first cluster includes countries such as 
Cyprus, Estonia, Latvia, Lithuania, Romania and Turkey. The main characteristics of this group 
are short duration of expansions (with the exception of Turkey are below the European average) 
and large amplitude of the recessions. The length of expansions seems to be equal to the length of 
recessions and thus the gains of first are canceled by the latter. 
The second group includes the Nordic countries, the Czech Republic and Slovakia, whose 
cycles are characterized by brief and mild recessions and convex expansions. On average, 
the expansions amount 33 months and the recessions 13 months. In absolute terms, the 
amplitude of expansions is two times higher than the amplitude of recessions. 
The third cluster containing the majority of EU-15 countries is composed of economies 
with  lower  amplitudes  of  both  expansions  and  recessions.  The  average  duration  of 
expansions is 28 months and of recession is 18 months. The amplitude of expansions is 
slightly higher than of recessions, both being generally moderate. 
The last group includes Ireland, Hungary and Poland, whose business cycles generally 
have atypical features. Their expansions are very long (the average is 44 months) and 
recessions are very short (9 months). The amplitude of expansions is 3 times higher than 
that of recessions, which made them very convex. Thus, these countries have achieved 
very good economic results during the recent years’ expansions. 
Very different cyclical movements in European countries have made even Michael Artis, 
a supporter of the existence of a common European business cycle, to become somewhat 
more skeptical. Thus, in 2003, he says that "the European business cycle is a more elusive 
phenomenon than we might have expected, whilst some European countries seem 'to stick 
together', there are many which do not."
 211 
                                                       
209 Uwe Bower, Catherine Guillemineau; “Determinants of Business Cycle Synchronisation across Euro 
Area Countries”; European Central Bank; Working Paper Series no. 587; February 2006. 
210 Maximo Camacho; Gabriel Perez-Quiros; Lorenna Saiz; „Do European Business Cycles look like 
one?”; Journal of Economic Dynamics and Control; vol. 32, nr. 7, 2008. 
211 Michael Artis; “ Is there a European Business Cycle?”, CESifo Working Paper no. 1053; 2003; pag. 4. 335 
 
Even  if  overall  cyclical  correlation  in  the  European  Union  is  relatively  low  and  volatile, 
Massmann and Mitchell believes that the business cycles of the euro area can be compatible even 
if  they  are  not  converging
212.  This  would  imply  a  closer  cyclical  movement,  decreasing  the 
cyclical disparities. Any reduction of these disparities means actually an increase in correlation 
between European business cycles. In this context, it is interesting to analyze the factors that 
determine this reduction of disparities and a better cyclical synchronization. 
 
The determinants of cyclical synchronization 
The  intensity  of  foreign  trade  appears  to  be  the  most  important  determinant  of  the 
synchronization  of  business  cycles  in  the  euro  area.  A  stronger  synchronization  of  national 
business cycles is determined only by the intra-industry trade, by the existence of similarities in 
industrial  structures  of  EU  countries.  Basically,  similar  industrial  specialization  means  a 
development  of  intra-industry  trade  and  a  stronger  cyclical  correlation  cyclical,  with  similar 
responses to similar shocks. The problem occurs when integration leads to a regional industrial 
specialization.  In  this  situation,  especially  the  neighboring  countries  could  achieve  a  better 
cyclical synchronization and a more effective common monetary policy. 
Another determinant of the business cycle synchronization is monetary integration. This may 
lead  to  a  better  synchronization  by  reducing  the  monetary  policy  asymmetries.  However, 
monetary integration has a major impact on trade through exchange rate stability. But monetary 
integration can sometimes cause a weaker synchronization of economic cycles. The existence of 
a single currency and the lack of an exchange rates mechanism in the hands of national monetary 
authorities determine only real sector adjustments in case of an external shock. The exchange rate 
mechanism  often  works  as  an  extremely  important instrument  of adjustment in  the  event  of 
exogenous shocks. 
Financial integration may lead to a stronger synchronization of business cycles by affecting the 
demand in different countries. The decline of a capital market means a decline of demand in the 
countries whose investors are affected by the fluctuations in that falling market. Contagion effect 
of  fluctuations  in  financial  markets  is  reflected  in  the  cyclical  fluctuations  of  the  financial 
integrated countries. But financial integration may as well stimulate specialization of production 
through reallocation of capital, which will lead to a different exposure to industrial shocks and a 
weaker synchronization of business cycles. 
 
Conclusions 
Even if it has argued that the steps taken by the European Union toward monetary integration has 
meant a stronger correlation of the business cycles in European countries, the reality shows that 
we can not yet speak of a "monotonous" trend toward a European business cycle. For most of its 
history,  the  cyclical  movement  in  European  Union  meant  a  succession  of  convergence  and 
divergence periods. Some European countries seem to have more similar business cycles, but 
there  still  persists  high  differences  between  different  groups  of  states.  A  common  monetary 
policy would be more effective if national business cycles should be closely correlated. Being in 
distinct cyclical phases, various European countries will not benefit from the same monetary 
recipes. Closer commercial ties, the integration of financial markets, the convergence towards 
monetary  integration  are  just  some  necessary  conditions  for  a  better  correlation  of 
macroeconomic  structures.  But  the  business  cycle  remains  the  most  complex  economic 
phenomenon,  closely  related  to  most  intimate  economic  foundations. To  speak  of  a  genuine 
European  business  cycle  we  should  speak  first  of  a  deep,  complete  integration  of  all  the 
                                                       
212Michael  Massmann;  James  Mitchell;  “Reconsidering  the  evidence:  are  Eurozone  business  cycles 
converging?”; National Institute of Economic and Social Research Discussion Paper no. 210; 2003. 336 
 
economic, institutional, political, commercial, industrial etc. structures in the European Union 
member states. 
 
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THE EUROPEAN BUSINESS CYCLE

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THE EUROPEAN BUSINESS CYCLE

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