The Convergence of European Business Cycles 1978-2000

TL;DR

This paper analyzes the convergence of European Union business cycles from 1978 to 2000 using random matrix theory, finding significant and stable correlations among core EU economies but not with the UK.

Contribution

It applies random matrix theory to assess true correlations in EU business cycles, providing empirical evidence of convergence among core EU economies over two decades.

Findings

Core EU economies show substantial, stable correlations in business cycles.

UK's business cycle does not show increased convergence with EU core economies.

Correlations contain true information, not noise, indicating genuine economic synchronization.

Abstract

The degree of convergence of the business cycles of the economies of the European Union is a key policy issue. In particular, a substantial degree of convergence is needed if the European Central Bank is to be capable of setting a monetary policy which is appropriate to the stage of the cycle of the Euro zone economies. We consider the annual rates of real GDP growth on a quarterly basis in the large core economies of the EU (France, Germany and Italy, plus the Netherlands) over the period 1978Q1 - 2000Q3. An important empirical question is the degree to which the correlations between these growth rates contain true information rather than noise. The technique of random matrix theory is able to answer this question, and has been recently applied successfully in the physics journals to financial markets data. We find that the correlations between the growth rates of the core EU economies contain substantial amounts of true information, and exhibit considerable stability over time. Even in the late 1970s and early 1980s, these economies moved together closely over the course of the business cycle. There was a slight loosening at the time of German re-unification, but the economies are now, if anything, even more closely correlated. In contrast, the results obtained with a data set of the EU core plus the UK show no such trend. In the late 1970s and early 1980s, the UK economy did exhibit some degree of correlation with those of the core EU. However, there is no clear evidence to suggest that the UK business cycle has moved more closely into line with that of the core EU economies over the 1978-2000 period.