The main purpose of this paper is to analyze aggregate fluctuations and cyclical comovements in the Mercosur area, as well as to draw conclusions on macroeconomic policy coordination. Our primary concern will be to characterize the fluctuations in GDP. We basically follow the literature on optimum currency areas (OCA) and exchange-rate-regime choice. Therefore, the issues that we discuss here are to a great extent those treated in that literature: the degree of symmetry of the business cycles, the identification of the sources of shocks, volatility, and the interactions between the cyclical movements of output and prices.
Our treatment of cyclical fluctuations, nonetheless, departs from the literature insofar as the emphasis we give to certain factors. This is basically due to the fact that the Mercosur presents a series of particularities that must be incorporated into the analysis. The most relevant are: first, that the Mercosur is a relatively recent regional integration agreement in which the degree of economic and trade integration is still low; second, its members are instability-prone medium-income countries and some are highly dollarized; and third, the countries have been hit by sizable shocks in the last five years and this has been detrimental to the integration process.
In our view, the particularities of the Mercosur macroeconomic setting indicate that focusing exclusively on the problem of the symmetry of business cycles may not be the best research strategy. In the OCA-inspired studies on the cycle, the identification of common shocks and of the degree of harmony in the adjustment process play prominent roles because of their primary interest on the cost-and-benefit analysis of renouncing the independence of monetary policy. In the case of Mercosur, the problem of relinquishing monetary policy in favor of a common one with the members of an eventual monetary union is not the most pressing issue of the day. The key macroeconomic policy question poses whether regional actions can be taken to reduce the volatility of some variables—the real bilateral exchange rate in the first place— thereby facilitating the process of integration. A closely related question considers what institutional framework at the regional level and what domestic policy regimes can best support the coordination efforts. More specifically, among the most urgent problems at present are: what kinds of rules/practices should be set to reduce volatility in the short-run and coordinate a process of long-run convergence in the dynamic path of fundamental macroeconomic variables? Given the existing differences in the macroeconomic situation and policy stance in the four countries, what combination of exchange rate regimes in each country would best facilitate the convergence process? Are there “cheap” policy initiatives that can be implemented regionally? That is, are there “x-inefficiencies” in the conduct of macroeconomic policies that can be eliminated through coordinated regional initiatives?
These policy questions raise two points that merit particular attention on the business cycle research agenda. The first is volatility. It is a well-documented fact that stochastic processes characterizing key macroeconomic variables tend to be more unstable in developing countries. In particular, the size and variance of shocks are large and the parameters of the stochastic processes frequently show unexpected changes (“structural breaks”). Many authors observed that certain features of the economic structure may be the source of excessive volatility. In his work on the US regional cycle, Kouparitsas (2002) found that, in those US regions that devote a disproportionate share of their industrial activity to the production of commodities, region- specific cycles are dominated by fluctuations in commodity prices that are largely exogenous to the region; region-specific shocks explain almost thirty percent of the business cycle variation. In those states in which industrial composition is virtually identical to that of the aggregate US economy, on the other hand, region-specific shocks account for an insignificant share of the business cycle variation in income.
According to Kenen (1969), if countries specialize in distinct goods, they will be affected very differently by a given disturbance. Elaborating on this idea, Eichengreen and Taylor (2003) show that real exchange rate variability is associated with trade dissimilarity between partners. In the case of Mercosur, Fanelli and Heymann (2002) highlight the role of financial fragility and dollarization. But there is also evidence that causality runs both ways: high volatility leaves traces in the economic structure as well. In our previous work on the exchange rate (Fanelli, González-Rozada, and Keifman, 2001), we observed that higher volatility is associated with more rapid adjustment toward equilibrium, which may have to do with shorter contracts when the context is volatile. Likewise, there is evidence that excessive macroeconomic volatility erodes the financial structure resulting in weak financial deepening. Missing markets for financial contracts of larger duration and, especially, for spreading risk, are a canonical feature of the region. This suggests that financial aspects should play a significant role in the analysis of shocks and propagation mechanisms.
The second point that deserves attention on the research agenda is the relationship between idiosyncratic and common (regional) cycles. When the degree of integration is low and the market structure has significant missing markets, one would expect—ceteris paribus—a low correlation of business cycles. However, a low correlation of cyclical movements does not mean that there are no coordination opportunities to exploit. The countries could still reduce macroeconomic volatility by implementing mechanisms to exchange idiosyncratic risks. The implementation of these mechanisms should improve both macroeconomic stability and wel-fare because it would expand trading opportunities and permit exchanging risks that could not otherwise be exchanged insofar as the international markets for transacting those risks are clearly missing. For these mechanisms to be designed and implemented, it is critical to fully comprehend the relationship between common and idiosyncratic cycles and to identify regional propagation mechanisms within a unified methodological framework.
The issues that we study in this paper are closely related with these two points. The rest of the paper is organized as follows. The second section presents the stylized facts of output fluctuations in Mercosur. The purpose is twofold: to present empirical evidence and to motivate the analysis. The third reviews and discusses the approaches used in previous studies on cyclical comovement in Mercosur and proposes some innovations for addressing the issues raised in the introduction and in the section dealing with stylized facts. The fourth section presents the estimates of a VAR model for identifying supply and demand shocks based on the Blanchard and Quah (1989) methodology (BQ hereafter) and examines the weaknesses of this approach to account for price/output dynamics in Mercosur. The fifth section presents estimates of the common and idiosyncratic cycles in Mercosur. We apply the unobserved component methodology developed by Watson (1986) and Kouparitsas (2002) to identify the common (regional) and idiosyncratic (national) components of cyclical fluctuations in the region. We also investigate the relationship between the estimated common cycle and changes in financial conditions. The sixth section concludes the paper.
Download
PDF Ebook Business Cycles and Macroeconomic Policy Coordination in Mercosur
