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Chapter 4: Restoring Convergence between Member States in the EU and EMU
such as the EU, the effects of domes- Box 2: Types of macro-economic shocks
tic economic shocks and labour mar-
ket adjustment can often be rapidly Different types of shocks
transmitted to other Member States, in
particular through international trade, A shock on the supply side of the real sector affects, production technologies
labour mobility, knowledge networks (e.g. a decrease in productivity growth) or production factors (e.g. increases in
and capital flows. the price of raw materials), while a shock on the demand side of the real sector
affects, the preferences of consumers (e.g. a shift in propensity to consume), the
public sector (e.g. less military spending) or trading partners (e.g. a shift towards
Cross-border effects are determined by
the nature of the domestic shock, the overseas imports). In the long run, permanent real shocks induce adjustments
domestic adjustment to that shock and in the quantities and relative prices, to restore equilibrium — in the absence of
the strength of the channels through structural reforms. These changes may generate spill-overs to the rest of the world.
which shocks are transmitted across A permanent shock is defined as a shock that does not disappear and has a
borders. All of this can reinforce upward permanent impact, while a temporary shock has No permanent effect on trend
convergence if they involve, for example, developments. Nevertheless, as discussed elsewhere in this section, this distinc-
the dissemination of good business prac - tion does not hold once hysteresis effects in labour markets (and other markets)
tices across borders. However, they can are taken into account.
increase divergence if they involve, for A symmetric shock affects all economies in the same way (e.g. the rise in the price
example, the migration of highly skilled of oil affects all oil importers), while an asymmetric shock ( ) affects a specific
1
persons who want to escape adverse Member State (e.g. a boom in the domestic construction sector). Nevertheless,
socioeconomic developments in their while countries may be hit by a common shock, differences in (labour market)
home country.
institutions or other country specific characteristics (such as wage setting) may
generate asymmetric outcomes (at least in the short- to medium-term).
The scale and intensity of these cross-
border effects is largely conditioned An exogenous shock (e.g. a geopolitical crisis) is beyond the control of policy mak -
by the structural characteristics of the ers, while policy-induced shocks (e.g. unexpected bail-outs of banks) stem from
economies, such as their trade openness, discretionary policy decisions. Finally, shocks may be anticipated (e.g. introduction
their integration in cross-border supply of the euro) or unanticipated (i.e. ‘news’).
chains, their financial integration with Difficulties in identifying the nature of different shocks
the rest of the world, and their access
to international knowledge networks and Although knowledge of the nature of a shock that hits an economy is important,
market flexibility (see, for instance, IMF, it should be recognised that the exact nature of a shock is not always unambigu-
41
2013 and Weyerstrass et al., 2006) ( ). ously observable in real time, and estimations confront several issues.
First, it cannot be excluded that national policy makers may have an incentive to
misrepresent the nature of a shock. Consequently, it may be useful to establish an
institutional framework that provides an independent assessment of the nature
of shocks and macro-economic outlooks.
Furthermore, literature provides several methodologies to estimate (sources of)
business fluctuations (including output gaps). Seminal work include Tinbergen
(1939) using a linear difference equation, Burns and Mitchel (1946) using leading
indicators, Shapiro and Watson (1989) using multivariate dynamic factor models,
and Hamilton (1989) using a Markov-based regime shifting models. Neverthe-
less, experience has shown that real time estimates can be very uncertain, inter
alia, due to parameter instability, model uncertainty, and data revisions. See, for
instance, Marcellinoa and Musso (2011), Cheremukhin (2013) and Orphanides
and van Norden (2002).
( ) Sometimes referred to as ‘country-specific shocks’.
1
( ) Empirical assessments of spill-over effects
41
within EMU in the face of budgetary
consolidation and structural reforms prior
to the crisis can be found in, for example,
Weyerstrass et al. (2006) and Beetsma and
Giuliodori (2011).
221
such as the EU, the effects of domes- Box 2: Types of macro-economic shocks
tic economic shocks and labour mar-
ket adjustment can often be rapidly Different types of shocks
transmitted to other Member States, in
particular through international trade, A shock on the supply side of the real sector affects, production technologies
labour mobility, knowledge networks (e.g. a decrease in productivity growth) or production factors (e.g. increases in
and capital flows. the price of raw materials), while a shock on the demand side of the real sector
affects, the preferences of consumers (e.g. a shift in propensity to consume), the
public sector (e.g. less military spending) or trading partners (e.g. a shift towards
Cross-border effects are determined by
the nature of the domestic shock, the overseas imports). In the long run, permanent real shocks induce adjustments
domestic adjustment to that shock and in the quantities and relative prices, to restore equilibrium — in the absence of
the strength of the channels through structural reforms. These changes may generate spill-overs to the rest of the world.
which shocks are transmitted across A permanent shock is defined as a shock that does not disappear and has a
borders. All of this can reinforce upward permanent impact, while a temporary shock has No permanent effect on trend
convergence if they involve, for example, developments. Nevertheless, as discussed elsewhere in this section, this distinc-
the dissemination of good business prac - tion does not hold once hysteresis effects in labour markets (and other markets)
tices across borders. However, they can are taken into account.
increase divergence if they involve, for A symmetric shock affects all economies in the same way (e.g. the rise in the price
example, the migration of highly skilled of oil affects all oil importers), while an asymmetric shock ( ) affects a specific
1
persons who want to escape adverse Member State (e.g. a boom in the domestic construction sector). Nevertheless,
socioeconomic developments in their while countries may be hit by a common shock, differences in (labour market)
home country.
institutions or other country specific characteristics (such as wage setting) may
generate asymmetric outcomes (at least in the short- to medium-term).
The scale and intensity of these cross-
border effects is largely conditioned An exogenous shock (e.g. a geopolitical crisis) is beyond the control of policy mak -
by the structural characteristics of the ers, while policy-induced shocks (e.g. unexpected bail-outs of banks) stem from
economies, such as their trade openness, discretionary policy decisions. Finally, shocks may be anticipated (e.g. introduction
their integration in cross-border supply of the euro) or unanticipated (i.e. ‘news’).
chains, their financial integration with Difficulties in identifying the nature of different shocks
the rest of the world, and their access
to international knowledge networks and Although knowledge of the nature of a shock that hits an economy is important,
market flexibility (see, for instance, IMF, it should be recognised that the exact nature of a shock is not always unambigu-
41
2013 and Weyerstrass et al., 2006) ( ). ously observable in real time, and estimations confront several issues.
First, it cannot be excluded that national policy makers may have an incentive to
misrepresent the nature of a shock. Consequently, it may be useful to establish an
institutional framework that provides an independent assessment of the nature
of shocks and macro-economic outlooks.
Furthermore, literature provides several methodologies to estimate (sources of)
business fluctuations (including output gaps). Seminal work include Tinbergen
(1939) using a linear difference equation, Burns and Mitchel (1946) using leading
indicators, Shapiro and Watson (1989) using multivariate dynamic factor models,
and Hamilton (1989) using a Markov-based regime shifting models. Neverthe-
less, experience has shown that real time estimates can be very uncertain, inter
alia, due to parameter instability, model uncertainty, and data revisions. See, for
instance, Marcellinoa and Musso (2011), Cheremukhin (2013) and Orphanides
and van Norden (2002).
( ) Sometimes referred to as ‘country-specific shocks’.
1
( ) Empirical assessments of spill-over effects
41
within EMU in the face of budgetary
consolidation and structural reforms prior
to the crisis can be found in, for example,
Weyerstrass et al. (2006) and Beetsma and
Giuliodori (2011).
221
