What does it take to grow out of recession? An error-correction approach towards growth convergence of European and transition countries

Consequences from the subsiding 2008 financial crisis on long-run economic growth are widely debated. Existing literature on previous recessions, such as Cerra and Saxena (2008), emphasizes the long-term loss inflicted on per capita GDP levels. This paper concentrates on typical business cycles in advanced European and transition countries and assumes that lower than normal growth during recessions is followed by a recovery period with above normal growth until the economy reaches its pre-crisis level. The objective is to assess the capacity to rebound, the speed of convergence towards a normal growth path as well as potential nonlinearities. Through exploiting the cointegration relationships among variables in long-run growth regressions and by employing a variety of panel error-correction models, results show a strong evidence of error-correction and different linear speed in the convergence process with the transition economies outpacing Western European countries. Our analysis is further extended into a Panel Smooth Transition Error-Correction Model (PSTR-ECM) to account for different regimes in convergence patterns according to a selection of transition variables. Whereas the velocity of convergence for European core countries exhibits a nonlinear pattern and differs with respect to price and flexibility, transition countries remain linear in their return to the growth trend. Ultimately, our results suggest that internal adjustments remain the key factors for both European and transition countries to recover from negative economic growth shocks.