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: www.cepr.org/pubs/dps/DP4726.asp

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.