Business cycles fluctuations determinants in the EMU: a fixed-effects panel data analysis

Abstract

This master thesis purposes to address some fundamental questions concerning the determinants of the business cycles fluctuations. In a public policy context the relationship between fiscal policy variables with these fluctuations are of particular importance. Furthermore, in a monetary union fiscal policy is the foremost tool to deal with country-specific fluctuations. This thesis is trying to acknowledge the particular importance of fiscal policy in the EMU context estimating panel data equations for the twelve countries of the EMU for the years 1995-2009. Additionally, other variables such as trade openness and the dummy variables, elections and EMU formation are added to extract a clearer image. Also, aspects of divergence and synchronization are extracted through using fixed-effects analysis. To that end, various econometric techniques were used among others EGLS, GLM, spectral analysis, fixed-effect models. Synchronization issues recurrently come up, suggesting a core-periphery distinction among the EMU countries. Social benefits are found to be the most effective fiscal variable in the governments’ hands, while, capital expenditures and indirect taxes are the most pro-cyclical variables from the variable set. Openness is found to be counter-cyclical, in accordance with at least a part of the literature. Also, elections are found to be pro-cyclical giving evidence for the existence of opportunistic political business cycle. Next, we found that EMU countries exert different periodicities in the movements of output. The different periodicities make common monetary policy inappropriate and thus make countries in a monetary union asynchronous. At the same time differences in the effectiveness of fiscal policy variables in countries of the EMU, measured by deviations from the equation – fixed effects – make the picture even vaguer. More precisely the countries that form the acronym PIGS are found with the largest deviation from the business cycle determination. This fact has severe implications against the neoclassical hegemony of budget cuts as a response to the current crisis. In any case, a core-periphery distinction is suggested among the participants of the EMU in terms of deviations, as already suggested from the literature. Of course, our findings deserve careful screening given that business cycle synchronicity is an important indicator of the optimality of monetary union.