Title: Common versus country-specific factors in Euro Area output gap estimation
Authors: Florian Huber - Vienna University of Economics and Business (Austria)
Philipp Piribauer - Austrian Institute of Economic Research (WIFO) (Austria) [presenting]
Abstract: Optimum currency area (OCA) theory claims that the synchronization of business cycles is a prerequisite of a well-functioning currency union. In the absence of a certain degree of business cycle synchronicity, policy makers can hardly satisfy the needs of all member states simultaneously. Thus, if member states display a pronounced degree of business cycle heterogeneity, i.e. some countries tend to be in business cycle upturns whereas other countries face a situation where current output is markedly below potential output, designing appropriate area-wide monetary policy proves to be challenging. The aim is to study the nature and the co-movement of economic output trajectories in European countries in general, and its contribution to the European integration process in particular. We use a Bayesian dynamic factor modelling approach as a means to exploit the co-movements of European output trajectories. The modelling approach allows to unveil the properties of the employed common factors and trace their relative contribution over time. Specifically, a quantification of the explained volatility structure due to the establishment of the European Single Market can be assessed both in-sample as well as its relative importance in out-of-sample forecasting exercises.