DP4726 Convergence and Cycles in the Euro Zone

Author(s): Vasco M Carvalho, Andrew Harvey
Publication Date: November 2004
Keyword(s): balanced growth, error correction mechanism, Kalman filter, signal extraction, stochastic trend, unobserved components
JEL(s): C32, O40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4726

Multivariate unobserved components (structural) time series models are fitted to annual post-war observations on real income per capita in countries in the euro zone. The aim is to establish stylized facts about convergence as it relates both to long-run income levels and to cycles. The analysis is based on a new model in which convergence components are combined with a common trend and similar cycles. These convergence components are formulated as a second-order error correction mechanism that ensures that the extracted components change smoothly, thereby giving a clearer decomposition into long-run movements and cycles.