Why business cycles diverge? Structural evidence from the European Union

Abstract

The application of various measures of business cycle synchronization indicates that business cycle divergence is a robust feature of GDP time series in the European Union. An analysis of the sources of the divergence has demonstrated that the determinants of business cycle comovement in economics literature cannot explain this situation. In contrast, they imply that the cycles should converge. An alternative cause of divergence is investigated at the sectoral level using the Bayesian dynamic factor model. The results reveal that, on average, 73 % of the international comovement is driven by sectoral factors, and the manufacturing sector is the main carrier of international business cycles. The unique standing of manufacturing can be attributed to the unparalleled extent of sectoral linkages in the sector. Consequently, business cycle divergence in the European Union could be caused by a rapid decrease in the share of the manufacturing sector and a growing share of services characterized by low intersectoral linkages.

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