In this chapter we analysed the empirical pattern of business cycle convergence/divergence in the EU, especially with regard to cyclical comovements between the CESEE region and the euro area. In particular, we tested the decoupling versus convergence hypothesis for the CESEE region, as the impact of the catching-up process on business cycle synchronization is theoretically ambiguous. Moreover, in light of recent evidence, showing a decoupling of global emerging market economies from industrialized economies, we explored the development of trend growth differentials between the CESEE region and the euro area. The most important findings of our study can be summarized as follows.
Firstly, CESEE economies are still much more heterogeneous among each other than the countries in the euro area, with respect to both cyclical dispersion and correlation. Secondly, we observe a pronounced business cycle decoupling of CESEE countries from the euro area starting with the onset of the financial crisis in 2008, once again confirmed for both the dispersion of output gaps and cyclical co-movement. The results for the dispersion measure are mainly driven by smaller countries. This can be explained by the fact that small economies seem to have larger cyclical swings as they are more dependent on external demand, which causes a decoupling in terms of higher output gap deviations from the euro area cycle in times of economic crises. At the same time, this does not necessarily affect business cycle synchronization as measured by cyclical correlation, where the strength of the linear relationship of two cycles is measured. In fact, there is some evidence for a more pronounced decline in the co-movement of larger economies from the euro area cycle. Despite the observed declines of correlation coefficients during two particular time spans after 2007, the average cyclical correlation of the CESEE economies with the euro area has risen significantly after their EU accession in 2004. Furthermore, at the end of the sample, a ‘recoupling’ of the CESEE countries to the euro area economy can be observed. Overall, the already high correlations of cyclical components with the euro area cycle imply quite favourable conditions for a common monetary policy in CESEE if the new member states in CESEE decide to join the euro area.
Thirdly, we find a significant decoupling of trend growth rates between the euro area and the CESEE region until the onset of the financial crisis in 2008, which is in line with recent observations concerning the decoupling of global emerging market economies from industrialized economies. Moreover, trend growth rates have declined during the crisis both in the CESEE region and the euro area, which resulted in a considerable reduction of the growth differential between the two regions from around four to approximately two percentage points. If one assumes that the growth differential stays at two percentage points from now on, the GDP levels would be aligned by 2050. Interestingly, the growth differential between the euro area and the CESEE region observed in the early 2010s is mainly driven by large CESEE economies, with Poland’s trend growth rate being the major driver of this gap. Hence, from a long-run perspective, we conclude that the catching-up process of the CESEE region has continued, but slowed down considerably during the crisis. At the same time, the lower growth differential might also be a rebalancing towards a more sustained and balanced growth in the region, hopefully leading to a more stable process of income convergence.