Monday, June 22, 2009

Institutions do not affect the business cycle

There is now much talk about reforming market institutions in order to prevent crises. Whether those reforms will have an impact remains to be seen. But does institutional change have an impact on business cycles? An obvious natural experiment in this regard is Europe, where a common currency and monetary policy, the Maastricht Treaty as well as the free movement of goods and people.

Fabio Canova, Matteo Ciccarelli and Eva Ortega look at this using a panel VAR with countries in and outside the European Union. They find that there is a slow change in terms of synchronization and transmission of business cycles, but this seems unrelated to institutional change and rather part of the long process of convergence that started over 100 years ago. The timing of change is simply not right. Does this mean institutions are not important? Not necessarily, as this study looked at fluctuations, not levels.

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