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Financial Differences and Business Cycle Co-Movements in A Currency Area



I propose a unitary framework to interpret the links between differences in financial structures and the monetary policy regimes on the one hand, and the correlation of business cycles on the other. Using a two-country micro-founded model with financial frictions I predict that a greater financial diversity should reduce cyclical correlation under a given monetary regime, and that moving from independent monetary policies to a hard peg or a common currency should increase it, for any given degree of financial diversity. I use the recent experience of EMU to test these ideas, and show that my model explains reasonably well the broad patterns of business cycle correlation observed recently among the main euro area countries.

Suggested Citation

  • Ester Faia, 2005. "Financial Differences and Business Cycle Co-Movements in A Currency Area," Working Papers 97, Oesterreichische Nationalbank (Austrian Central Bank).
  • Handle: RePEc:onb:oenbwp:97

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    References listed on IDEAS

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    Cited by:

    1. J.M.C. Santos Silva & Silvana Tenreyro, 2010. "Currency Unions in Prospect and Retrospect," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 51-74, September.
    2. repec:onb:oenbwp:y::i:162:b:1 is not listed on IDEAS
    3. PIROVANO, Mara, 2013. "International financial integration, credit frictions and exchange rate regimes," Working Papers 2013015, University of Antwerp, Faculty of Applied Economics.
    4. Enders, Zeno & Jung, Philip & Müller, Gernot J., 2013. "Has the Euro changed the business cycle?," European Economic Review, Elsevier, vol. 59(C), pages 189-211.
    5. Enders, Zeno & Jung, Philip & Müller, Gernot J., 2013. "Has the Euro changed the business cycle?," European Economic Review, Elsevier, vol. 59(C), pages 189-211.
    6. Ester Faia, 2010. "Financial Frictions And The Choice Of Exchange Rate Regimes," Economic Inquiry, Western Economic Association International, vol. 48(4), pages 965-982, October.
    7. Gieck, Jana, 2014. "Unconventional monetary policy in an open economy," Discussion Papers 41/2014, Deutsche Bundesbank.
    8. Natalia T. Tamirisa & Alain N. Kabundi & Deniz O Igan & Francisco d Nadal De Simone & Marcelo Pinheiro, 2009. "Three Cycles; Housing, Credit, and Real Activity," IMF Working Papers 09/231, International Monetary Fund.
    9. Nikolay Hristov & Oliver Hülsewig & Timo Wollmershäuser, 2014. "Financial Frictions and Inflation Differentials in a Monetary Union," Manchester School, University of Manchester, vol. 82(5), pages 549-595, September.
    10. Bhattarai, Saroj & Lee, Jae Won & Park, Woong Yong, 2015. "Optimal monetary policy in a currency union with interest rate spreads," Journal of International Economics, Elsevier, vol. 96(2), pages 375-397.

    More about this item


    financial diversity; monetary regimes; differential transmission mechanism;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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