EU Enlargement and Endogeneity of some OCA Criteria: Evidence from the CEECs

Abstract

There are two opposite points of view on the link between economic integration and business cycle synchronization. De Grauwe (1997) classifies these competing views as 'The European Commission View' and 'The Krugman View'. According to the European Commission (1990), closer integration leads to less frequent asymmetric shocks and to more synchronized business cycles between countries. On the other hand, for Krugman (1993) closer integration implies higher specialization and, thus, higher risks of idiosyncratic shocks. Drawing on the evidence from a group of transition countries which have experienced a notable increase in trade openness and economic integration with the European Union during the past decade, this paper tries to determine whose argument is supported by the data. This is done by confronting estimated time-varying coefficients of supply and demand shock asymmetry with indicators of trade intensity and exchange rates. We find that (i) an increase in trade intensity leads to higher symmetry of demand shocks; the effect of integration on supply shock asymmetry varies from country to country; (ii) a decrease in exchange rate volatility has a positive effect on demand shock convergence. The results for demand shocks can be interpreted in favor of 'The European Commission View', also known as the endogeneity argument by Frankel and Rose (1998) in the OCA criteria discussion, according to which trade links reduce asymmetries between countries. Overall, our results support Kenen's (2001) argument that the impact of trade integration on shock asymmetry depends on the type of shock.EU enlargement, business cycle, trade, OCA (optimal currency area)