CYCLICAL CO-MOVEMENTS IN OUTPUT ACROSS
MERCOSUR COUNTRIES
CARLOS G. FERNÁNDEZ VALDOVINOS
DOCUMENTO DE TRABAJO DEL BANCO CENTRAL DEL PARAGUAY
Asunción - Paraguay
INTRODUCTION.
Preliminary discussions are being held on the prospects of a common currency in MERCOSUR, 1. For any country considering tojoin a single currency area, the advantages of fixing its exchange rate in terms of the other countries, or of adopting a common currency, must be carefully weighed against the disadvantage of doing so. The benefits of being a member of the area include a reduction in the transaction costs and exchange rate risk associated with trading goods and services between countries with different currencies. Another advantage of fixing the exchange rate is that this variable can be used as a nominal anchor for monetary policy allowing the country to attain a lower level of inflation, 2. The main cost is that entrants will forego the possibility of dampening business cycle fluctuations through independent counter-cyclic monetary policy. The theory of Optimum Currency Areas, developed initially by Mundell (1961) and McKinnon (1 963), remains the workhorse to examine the perspectives of a monetary unification. Contributions to this lit erature point to characteristics of countries t hat make stable exchange rate and/or monetary unification more or less desirable. Among the most important of these characteristics are, 3:
*. Asymmetric output disturbances between a given pair of countries: the greater the asymmetry of output movements, the higher the value placed on changes in the exchange rate as an instrument of relative price adjustment.
*.Dissimilarity of the commodity composition of production and trade: when commodity composition o f production and trade is very different across two countries, sector specific shocks are likely to affect them very differently, placing a premium on exchange rate variability.
*. Trade linkages: the more two countries trade the more they will value a stable bilateral exchange rate which minimizes relative price disturbances disruptive to commerce between them.
*. Size: small countries benefit the most from the unit of account, means of payment and store of value services provided by a common currency or a stable exchange rate link.
In this paper I use as a framework the familiar theory of Optimum Currency Areas. As mentioned before, the adoption of a common currency in MERCOSUR will involve a sacrifice by the countries of monetary autonomy that is potentially all the more serious. However, the weight that should be attached to this argument depends on the incidence of shocks. If disturbances are distributed symmetrically across countries, symmetrical policy responses will suffice. For example, when the region is hit by a negative disturbance, such as a shift in worldwide demand away from the goods it produce s, the common monetary authority could respond in the form o f a common monetary expansion so that the whole region does not go into recession. Only if disturbances are distributed asymmetrically across countries will t here be occasion for an asymmetric policy response and the constraints of monetary union may then be felt, 4.
Accordingly, in this work I focus on the issue of the symmetry of the underlying shocks in MERCOSUR countries. The main features of the aggregate fluctuations in the six countries of the said area are considered, using as a benchmark for comparison data on six countries belonging to the European Union (EU). I explore the direction and magnitude of the co-movements of output across countries and, in addition, study the association of their business cycles decomposing the series in output into cycles of different frequencies. Due to its widespread use in empirical economics, the Hodrick -Prescott filter is applied to mechanically decompose the individual series into a trend movement and a cyclical component. Correlation analysis is then used to summarize the extent to which the cyclical components exhibit co-movements across countries. Similarly, developments over time in the synchronization of the series cyclical component are examined on the basis of the contemporaneous cross correlation coefficients for rolling 10-year periods.
The remainder of the paper is organized as follows: Section 2 examines the raw data in output and calculates some simple statistics to analyze the volatility and correlation among countries of the original series. Section 3 employs methods of current business cycle research to determine the degree of cyclical co-movements between countries while Section 4 explores the hypothesis that the synchronization of business cycles is linked to lower exchange ratevolatility. Finally, Section 5 presents some conclusions.
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BIBLIOTECA VIRTUAL DEL BCP
BANCO CENTRAL DEL PARAGUAY
LIBRO DIGITAL
Fuente digital : www.bcp.gov.py
