Economic cycles in the United States and in the euro area : determinants, scale and linkages

This article analyses the business cycles observed in the euro area and in the United States on the basis of the estimated results of a general equilibrium model. In the first place it is shown that the cyclical movements in both economies show strong similarities : there are no significant divergences in the behavioural parameters of either the private sector or the monetary authorities, while also the various exogenous shocks, being the driving force behind the business cycles in this model, prove to be comparable in terms of scale and persistence. On the basis of the estimated models, the observed cyclical movements may be ascribed to various types of exogenous shocks, such as innovations in productivity, the labour supply, consumer preferences or economic policy. In the short term, the business cycles appear mainly to have been generated by demand shocks (preference and investment shocks, exogenous demand shocks and monetary shocks). During recession periods simultaneous demand shocks in consumption and investment spending appear to play an important part. In the long term, shocks affecting the labour supply and productivity are the driving forces. As to the inflation developments, especially temporary mark-up shocks prevail in the short term, although in the long term inflation is primarily a monetary phenomenon and is being guided by the inflation target of the central bank. The limited effect of monetary shocks on the real economy does not imply that monetary policy is insignificant. The systematic behaviour of the central bank is important in order to understand how the other shocks affect the economy. It is here that monetary policy can contribute to a more stable and efficient economic growth. In addition to the causes of the cyclical movements, the downward trend in the volatility of the economic aggregates is being discussed. The reduction of the volatility in real growth of both the euro area and the United States, especially since the mid 1980s, is mainly related to the fact that the size of the exogenous shocks has been smaller. Changes in the economic structure or dynamics and a more efficient monetary policy in themselves do not account for the sharp reduction of real volatility. The same findings may also help to explain the synchronisation of the business cycles between the two economic blocks. Despite the globalisation of the economy, there is no clear trend towards more correlation in economic growth. The relatively small scale of the simultaneous – predominantly demand-related – shocks having occurred recently, may provide some explanation. In the absence of severe synchronised shocks, country- or sector-specific shocks remained relatively important to the pattern of economic activity. As to the future, this implies that it would be wrong to be too optimistic about the dynamic stability of the economy or the efficiency of stabilisation policies.