Trends and cycles in the euro area: how much heterogeneity and should we worry about it?

The paper analyses output dynamics in Euro area countries in the last thirty years. It establishes robust stylized facts on output differentials within the union, on the synchronization of recessions within the area countries and on similarities and differences with respect to the US case. Finally, it provides estimates of changes in the degree of risk sharing since the early nineties. The paper finds that, since 1970, within the Euro area, gaps in levels of income per capita have been persistent. This implies that it is difficult to distinguish convergence patterns from persistent fluctuations around different means. However, these gaps are small and business cycle characteristics, when measured by levels of output, have been very similar across countries. Output variance, the paper finds, is mainly explained by common shocks with similar propagation mechanisms while idiosyncratic shocks, although persistent, are small. These characteristics are in line with what found for US regions. An implication of this result is that policy should be concerned with the common characteristic of the European cycle. The next step of the analysis is then to compare the characteristics of the Euro area cycle with the US cycle. It is found that the two cycles are driven by a common world shock, but that the propagation of the shock differs across the two areas: the Euro Area lags the US and its cycle is more persistent, but less volatile. Low growth, persistence of shocks and low volatility are common characteristics of the Euro area and the gap with respect to the US has been stable over the last thirty years. Facing these historical characteristics, the process of European integration, has however helped to smooth the cross-sectional correlation of consumption conditional on output. This finding supports the hypothesis that, since the early nineties, risk sharing has increased within the Euro Area. JEL Classification: E32, C33, C53, F2, F43