Business cycles in the euro area

Michele Lenza, Lucrezia Reichlin, Domenico Giannone 15 January 2009



The Euro recently celebrated its tenth birthday. The celebration has been an occasion for reflection on the experience of the European Economic and Monetary Union (EMU). One of the conclusions emerging from this reflection is that the lack of national monetary policy and exchange rate tools, contrary to the fears of some of the euro critics, have not changed the pattern of business cycle correlations across member countries.

European business cycles

Characterising euro-area business cycles is a contested topic, as the clustering of institutional changes in the early 1990s and the short data sample describing the EMU make robust results hard to find. But even business cycle correlations prior to the adoption of the euro lack consensus. Lumsdaine and Prasad (2003) found a clear European business cycle from 1973 to 1994, while Helbling and Bayoumi (2003) found little synchronisation across the G7 from 1973 to 2001, though there were strong cross-country correlations during recessions.

More recent work examining the EMU reaches no consensus. Using data through 2007, Canova, Ciccarelli, and Ortega (2008) find no European cycle prior to the mid-80s, while an EU cycle emerges in the 1990s that is common to EMU and non-EMU members. Del Negro and Otrok (2008), with data from 1970 to 2005, find no change in average cross-country correlation of euro area business cycles and for the larger set of European countries.

In a recent paper (Giannone, Lenza and Reichlin, 2008), we document the pattern of business cycle correlations in detail by analysing business cycles for twelve euro-area countries from 1970 to 2006. We identify two groups, say `core’ and `non-core’. In the core group, levels of GDP per capita are similar and growth rates are highly synchronised. Among countries in the periphery, both levels and growth rates are very heterogeneous and the linkages between each of these countries and the rest of the euro area are relatively weak. For both groups, the inception of the euro has not produced any significant change in the magnitude of business cycle fluctuations or in the pattern of their cross-country correlations.

Can the EMU handle current shocks?

But history plays its tricks and after the celebration came the recession, probably the deepest since the seventies. Euro sceptics may think that only now, with the recent recession, the EMU will be subject to a serious test and that there will be a wide divergence in economic performance in the next couple of years.

How well founded is the renewed fear of the euro-sceptics? Is the EMU macroeconomic framework too inflexible to deal with large shocks? This fear does not seem to be justified on the basis of the latest World Economic Outlook (WEO) from the IMF.

Figure 1 plots levels of output per capita since 1970 for twelve countries of the euro area and the euro area aggregate. Figure 2 indicates corresponding growth rates. For both charts the values for the period 2008-2013 are the IMF forecasts. The `core’ countries are in blue, the `non-core’ are in red.

Figure 1. GDP per capita

Note: The dashed blue lines refer to the levels of GDP per head, PPP adjusted, in the core countries (Austria, Belgium, France, Germany, Italy and The Netherlands) while the dashed red lines refer to the non-core countries (Finland, Greece, Ireland, Luxembourg, Portugal and Spain). The solid blue line refers to the euro area aggregate. Data sources are OECD for the period 1970 – 2007 while the source for the forecasts from 2008 to 2013 is IMF World Economic Outlook.

Figure 2. GDP per capita growth rates

Note: The dashed lines refer to the annual growth rates of GDP per head, PPP adjusted, for countries, the solid line is the euro-area aggregate. See Figure 1 note for country assignments and data sources.

Looking at the figures shows that neither the EMU experience nor forecast outcomes involve larger cross-country divergence than in the past. In particular, the heterogeneity implied in the forecasts is not larger than in the past three recessions of the early seventies, early eighties and early nineties, nor the slowdown of the early millennium.

Analysing these data through the lens of a statistical model, we have estimated a multi-country vector auto-regression from 1970 to 1998 to counterfactually assume that the pre-EMU correlation structure has remained unchanged. We have computed the prediction for real GDP per capita growth in individual euro area countries, conditional on the path (observed and forecast) of real GDP per capita for the euro area as a whole.

Figures 3 and 4 compare our counterfactual conditional predictions with the observed and predicted real per capita GDP growth for two selected countries: Germany, from the core group, and Spain, from the non-core.

Figure 3. Conditional expectation – growth rate GDP per capita, Germany

Figure 4. Conditional expectation – growth rate GDP per capita, Spain

Note: The solid black line in the two figures refers to the country’s observed annual growth in GDP per capita, while the dotted line refers to observed annual growth in GDP per capita in the euro area. The red-shaded (purple-shaded) area depicts the 68% (95%) confidence band for the predictions of GDP growth in the country concerned.

For both the `core’ (Germany) and the `non-core’ (Spain) countries, fluctuations after the inception of the EMU are generally not significantly different from what would have been deduced on the basis of the pre-EMU economic structure. This is the case, not only when looking at the post-EMU experience, as documented in Giannone, Lenza and Reichlin (2008), but also when looking at the most recent IMF forecasts. Other countries from both groups show qualitatively similar behaviour.

Notice that for Spain the level of uncertainty surrounding the conditional predictions for output is higher than for Germany. This is the consequence of the weaker association of Spanish output dynamics with that of the euro area. This is the case for non-core countries both before and after the creation of the EMU. Although countries of the periphery are influenced by some sizeable idiosyncratic factors whose importance has not diminished over time, there is no indication that the formation of the EMU has had a significant effect on the business cycle in these countries and no indication that the current recession will be at odds with this fact. Of course, the last conclusion relies on the assumption that the IMF forecasts don’t under-estimate cross-country differences in GDP for the period 2008-2013.


Canova, F., M. Ciccarelli, and E. Ortega (2005): “Similarities and Convergence in G-7 Cycles,” Journal of Monetary Economics, 54, 85–878.
Del Negro, M., and C. Otrok (2008): “Dynamic factor models with time-varying parameters: measuring changes in international business cycles,” Staff Reports 326, Federal Reserve Bank of New York.
Giannone, D., M. Lenza and L. Reichlin (2008), “Business cycles in the euro area”, in Alesina A. and Giavazzi F. (eds.), Europe and the EMU , NBER, forthcoming.
Helbling, T., and T. Bayoumi (2003): “Are they all in the same boat? The 2000-2001 growth slowdown and the G-7 business cycle linkages,” IMF working paper 03-46.
Lumsdaine, R. L., and E. S. Prasad (2003): “Identifying the Common Component of International Economic Fluctuations: A New Approach,” Economic Journal, 113(484), 101–127.

1 We consider the twelve countries that were part of the euro area before December 2006: Austria, Belgium, France, Finland, Germany, Greece, Italy, Ireland, Luxembourg, Portugal, Spain and The Netherlands.




Topics:  EU institutions Monetary policy

Tags:  business cycles, European Monetary Union, fluctuations

Head of Section, D-G Research, Monetary Policy Division, Macroeconomics Section, European Central Bank

Professor of Economics, London Business School; Chair European Corporate Governance Institute; CEPR Research Fellow and trustee; IFRS Foundation trustee (chair steering committee sustainability reporting); Fellow of the British Academy; Fellow of the Econometric Society

Assistant Vice President, Federal Reserve Bank of New York; and Research Fellow, CEPR


CEPR Policy Research