OCCASIONAL PAPER SERIES NO. 45 / MAY 2006 OUTPUT GROWTH DIFFERENTIALS ACROSS THE EURO AREA COUNTRIES SOME STYLISED FACTS ISSN 1607148-4 by Nicholai Benalal, Juan Luis Diaz del Hoyo, Beatrice Pierluigi 9 771607 148006 and Nick Vidalis OCCASIONAL PAPER SERIES NO. 45 / MAY 2006 OUTPUT GROWTH DIFFERENTIALS ACROSS THE EURO AREA COUNTRIES SOME STYLISED FACTS1 by Nicholai Benalal,2 Juan Luis Diaz del Hoyo,2 Beatrice Pierluigi2 and Nick Vidalis2 In 2006 all ECB publications will feature This paper can be downloaded without charge from a motif taken http://www.ecb.int or from the Social Science Research Network from the €5 banknote. electronic library at http://ssrn.com/abstract_id=807419. 1 Helpful comments and suggestions were received from Robert Anderton, Hans-Joachim Klöckers and Ad van Riet as well as from euro area NCBs. Valuable comments from an anonymous referee are also acknowledged. 2 Correspondence address: European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany, e:mail: [email protected]; [email protected]; [email protected] and [email protected]. © European Central Bank, 2006 Address Kaiserstrasse 29 60311 Frankfurt am Main Germany Postal address Postfach 16 03 19 60066 Frankfurt am Main Germany Telephone +49 69 1344 0 Website http://www.ecb.int Fax +49 69 1344 6000 Telex 411 144 ecb d All rights reserved. Any reproduction, publication or reprint in the form of a different publication, whether printed or produced electronically, in whole or in part, is permitted only with the explicit written authorisation of the ECB or the author(s). The views expressed in this paper do not necessarily reflect those of the European Central Bank. ISSN 1607-1484 (print) ISSN 1725-6534 (online) CONTENTS CONTENTS ABSTRACT 4 2.3 Business cycle dating 39 2.4 Demand composition of the two EXECUTIVE SUMMARY 5 latest upswings 46 2.5 Cross-correlation analysis of INTRODUCTION 8 business cycles 48 2.6 Cross-correlation analysis of 1 DISPERSION OF OUTPUT GROWTH RATES countries’ business cycles with WITHIN THE EURO AREA 9 each demand component 51 1.1 Real GDP growth differentials: statistical evidence 9 APPENDICES 1.1.1 Dispersion in benchmark areas A1 Other measures of dispersion 53 (United States, former West A2 Output growth differentials within Germany, Spain and Italy) 11 the United States, former 1.1.2 Dispersion across the West Germany, Spain and Italy 56 OECD countries 12 A3 Detrending methods: a short review 58 1.1.3 Country developments A4 Comparison of potential behind euro area output output estimates by international growth dispersion 13 institutions 60 1.2 Decomposing GDP growth A5 Decomposition of GDP growth dispersion into cycle and trend dispersion into cycle and trend in components 15 weighted terms 61 1.2.1 Decomposition of real GDP A6 Dispersion of demand components: growth dispersion in the some additional charts 62 largest euro area economies 17 A7 Summary growth rates of demand 1.2.2 Decomposition of real GDP components 1970-2004. Tables 64 growth dispersion across non- A8 Cross country comparison of sectoral euro area OECD countries 18 composition of GDP. 1970-2004. 1.3 Analysis of output gap developments Tables 66 in individual countries 19 A9 Technical details of the Harding 1.4 Analysis of trend GDP growth and Pagan dating procedure 69 developments in individual A10 The Harding and Pagan dating countries 21 procedure applied to the 1.5 Supply-side composition 22 United States and the euro area 70 1.6 The role of demographics in explaining output growth REFERENCES 72 differentials 26 1.7 Demand-side composition 28 EUROPEAN CENTRAL BANK 1.8 Sectoral composition 31 OCCASIONAL PAPER SERIES 75 1.9 The role of “initial conditions” in GDP per capita in explaining growth differentials 34 2 SYNCHRONISATION OF BUSINESS CYCLES WITHIN THE EURO AREA 34 2.1 Measures of business cycle synchronisation 34 2.2 Comparison with synchronisation of non-euro area countries 38 ECB Occasional Paper No. 45 May 2006 3 ABSTRACT The aim of this study is to investigate the extent to which the dispersion of real GDP growth rates has changed over the past few years and whether the synchronisation of business cycles has increased among the euro area countries. The study is divided into two main parts. The first focuses on the dispersion of real GDP growth rates across the euro area countries, while the second studies the synchronisation of business cycles within the euro area. The study shows first that dispersion of real GDP growth rates across the euro area countries in both unweighted and weighted terms has no apparent upward or downward trend during the period 1970-2004 as a whole. Second, since the beginning of the 1990s, the dispersion of real GDP growth rates across the euro area countries has largely reflected lasting trend growth differences, and less so cyclical differences, with some countries persistently exhibiting output growth either above or below the euro area average. Among other things, this might be due to different trends in demographics, as well as to differences in structural reforms undertaken in the past. Thirdly, the degree of synchronisation of business cycles across the euro area countries seems to have increased since the beginning of the 1990s. This finding holds for various measures of synchronisation applied to overall activity and to the cyclical component, for annual and quarterly data, as well as for various country groupings. In particular, the degree of correlation currently appears to be at a historical high. In addition to these main findings, certain other stylised facts on dispersion and synchronisation are presented. JEL classification: C10, E32, O40. Key words: Dispersion of GDP growth across the euro area countries; Trend and Cycle; Synchronisation of business cycles within the euro area. ECB Occasional Paper No. 45 4 May 2006 E X E C U T I V E SUMMARY EXECUTIVE SUMMARY on the selection of certain parameters that need to be predefined homogeneously across The creation of the Single Market in 1993 and countries. They are also affected by the “end- the inception of EMU in 1999 constitute point problem”, namely the fact that the significant institutional changes that arguably estimates at the end of the sample period should have affected the evolution of economic are conditional on projections, which are activity across the euro area countries. The aim required to extend the historical dataset. of this study is to investigate the extent to which Analysing the business cycle synchronisation the dispersion of real GDP growth rates has across countries also means that the cycles changed over the past few years and whether the have to be dated. Similarly, there is more than synchronisation of business cycles has increased just one method for doing this, and certain among the euro area countries. It reviews the parameters need to be predefined homogeneously main stylised facts behind output growth across countries. differentials. A full analysis of the main determinants and causes of output growth Additionally, output growth differentials can be differentials across the euro area countries as analysed in unweighted terms, i.e. by giving well as of the related policy implications is equal importance to all countries, or in weighted beyond the scope of this study. terms. As the aim of this study is to present some stylised facts on output growth differentials The study is divided into two main parts. across the euro area countries, measures of The first focuses on the dispersion of real dispersion and synchronisation are initially GDP growth rates across the euro area computed in unweighted terms. However, as the countries, while the second studies the euro area is a weighted concept and the ECB’s synchronisation of business cycles within the monetary policy is geared to the euro area as a euro area. In intuitive terms, the dispersion of whole, it might also be relevant to consider real GDP growth rates across countries refers to weighted measures. The study therefore also the degree of difference between their output shows weighted measures of dispersion, serving growth rates at a certain point in time. The in turn to test the robustness of some of the synchronisation of business cycles refers to the results obtained in unweighted terms. The degree of co-movement of business cycles analysis presented in this study has been carried across countries over a certain period of time. out using conventional statistical techniques. These concepts may be related, as a lack of Although no formal econometric tests have synchronisation of business cycles may also been conducted to assess the statistical be evident in the dispersion of output growth significance of the results, the study includes a rates. Analysing both elements is useful for wide range of indicators that support its key providing a complete picture of the output findings. growth differentials. The key findings of the study are as follows: There are many ways of measuring dispersion and synchronisation, and none of the methods – Overall, the dispersion of real GDP growth used in this study is free from controversy and rates across the euro area countries in both empirical difficulties. For example, for the unweighted and weighted terms showed no analysis of output growth differentials, total apparent upward or downward trend during output must be decomposed into a cyclical the period 1970-2004 as a whole. Since and a trend component. However, there is 1999, however, dispersion in annual average not just one method of obtaining such a terms has declined somewhat. Compared decomposition. Consequently, a number of with certain benchmark areas, the current methods have been used to check the robustness degree of dispersion within the euro area, of the results.