An Unobserved Components Common Cycle For Australia? Implications For A Common Currency

An important requirement, prior to countries’ adopting a common currency or maintaining an independent monetary policy, is establishing the extent to which they share a common economic cycle and how susceptible they are to region-specific shocks. For example, Kouparitsas (2001) has examined whether 8 US BEA regions are largely subject to common sources of disturbance, and assesses whether their regional cycles are consistent with a common currency area for the US. Norman and Walker (2007) conclude for 6 Australian States that the major source of the State fluctuations is shocks which are common to all States. But their variance analysis also shows that each overall State cycle is driven partly by fluctuations specific to that State, in particular for Western Australia. Findings such as these also have important implications for the relative strengths of influence of fiscal and regional policies, and of external shocks. Using similar unobserved components methodology (e.g. Watson and Engle (1983), Kouparitsas (2001, 2002), Norman and Walker (2007), and Hall and McDermott (2008)), we establish an Australasian common cycle, and assess the extent to which the region-specific cycles of 6 Australian States and NZ are additionally important. Our results suggest that: (1) structural breaks play an important role; (2) New Zealand’s region-specific growth cycle has exhibited distinctively different features, relative to the common cycle; and (3) for every Australasian region, the regionspecific cycle variance dominates that of the common cycle. Our findings on the distinctiveness of New Zealand’s output and employment cycles are consistent with New Zealand retaining the flexibility of a separate currency and monetary policy.