Faculty of Economics and Business Administration Publications Database

Financial Differences and Business Cycle Co-Movements in A Currency Area

Volume: 39
Number: 1
Pages: 151 - 185
Month: February
ISSN-Print: 0022-2879
Link External Source: Online Version
Year: 2007
Keywords: Financial diversity; Monetary regimes; Differential transmission mechanism
Abstract: I propose a unitary framework to interpret the links between differences in financial structures and the monetary policy regimes, on the one hand, and the correlation of business cycles, on the other. Using a two-country micro-founded model with financial frictions I predict that a greater financial diversity should reduce cyclical correlation under a given monetary regime and that moving from independent monetary policies to a hard peg or a common currency should increase it, for any given degree of financial diversity. I use the recent experience of EMU to test these ideas and show that my model explains reasonably well the broad patterns of business cycle correlation observed recently among the main euro area countries.