The Nature and Propagation of Shocks in The Euro A

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The nature and propagation of shocks in the euro area: a comparative SVAR
analysis
Article · January 2017

DOI: 10.1504/IJCEE.2017.10000627
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Int. J. Computational Economics and Econometrics, Vol. 7, Nos. 1/2, 2017 95
The nature and propagation of shocks in the euro

area: a comparative SVAR analysis
Alberto Coco* and Andrea Silvestrini

Bank of Italy,
Via Nazionale, 91, 00184 Roma, Italy
Email: alberto.coco@bancaditalia.it
Email: andrea.silvestrini@bancaditalia.it
*Corresponding author
Abstract: This paper investigates the nature and the propagation of

macroeconomic shocks hitting the euro area, in order to draw indications on the
functioning and viability of the monetary union after 15 years from its inception.
Structural VAR models identified with sign restrictions for a large set of euro-
area countries allow comparing the properties of three independent shocks over
different sample periods, before and after the start of the EMU. Results show
that, up to the third quarter of 2008, shocks on average have increased their
co-movement and decreased their size and persistence in eurozone countries,
compared with two control countries inside the European Union but outside the
euro area (UK and Sweden). Conversely, following the outbreak of the global
financial crisis, shocks have become on average more harmful for the euro area,
as testified by their larger size and persistence relative to those in the two control
countries.
Keywords: OCA; optimum currency area; EMU; Economic and Monetary Union;
SVAR; structural VAR; sign restrictions; symmetry; size and adjustment speed.
Reference to this paper should be made as follows: Coco, A. and Silvestrini, A.

(2017) ‘The nature and propagation of shocks in the euro area: a comparative
SVAR analysis’, Int. J. Computational Economics and Econometrics, Vol. 7,
Nos. 1/2, pp.95–114.
Biographical notes: Alberto Coco is an Economist at the Market Operations

Directorate of the Bank of Italy. He holds a PhD in Economics from the Université
catholique de Louvain and a Master in Economics from the Bocconi University
in Milan. His research interests include monetary policy and macroeconomic
modelling.
Andrea Silvestrini is an Economist at the Economic Outlook and Monetary Policy

Directorate of the Bank of Italy. Prior to joining the Bank, he was a Postdoctoral
Researcher at Università degli Studi di Perugia, where he received a PhD in
Statistics. He also holds a PhD in Economics from Université catholique de
Louvain – Université libre de Bruxelles and a Master in Economics from the
Université catholique de Louvain. His research interests are in time series analysis
and applied macroeconometrics.
Copyright © 2017 Inderscience Enterprises Ltd.

96 A. Coco and A. Silvestrini
1 Introduction
According to the theory of optimum currency area (OCA), the degree of symmetry of shocks
across countries is one of the main indicators to assess the feasibility and sustainability of
a currency union (on benefits and costs of currency areas, see Mundell, 1961; McKinnon,
1963; Kenen, 1969): in particular, the size and persistence of asymmetric shocks should be
as low as possible, given that member countries forego their own instruments – monetary
and exchange rate policy – to face them. Asymmetric shocks may be either country-specific
– in particular supply and demand shocks – or rather generated by asymmetric responses
to common shocks – typically the asymmetric transmission of the common monetary
policy. They can be absorbed more easily if the currency area features a high degree of
synchronisation in national business cycles, financial and trade integration, labour mobility
and wage/price flexibility, together with a sound system of public finance.
In this context, the purpose of this paper is to analyse the nature and the propagation of
aggregate supply, demand and monetary policy shocks in the euro area, examining whether,
after the creation of the Economic and Monetary Union (EMU), these shocks have become
more synchronised – or symmetric – and have reduced their impact on eurozone countries. In
this regard, asymmetric supply shocks are particularly harmful and costly for a currency area
because they mirror business cycles not (or little) synchronised across countries, making
the common monetary policy less effective. Therefore, this analysis has relevant policy
implications, also in light of the global financial crisis, which has raised concerns over the
optimality and the sustainability of the EMU (Caporale et al., 2015).
This paper investigates this issue after 15 years from the EMU implementation since,
as argued by Frankel and Rose (1998), the economic conditions that determine a country’s
suitability for entering into a currency area are endogenous. As explained by Willett et al.:
“In general, potential members of a monetary union would be expected to meet the OCA
criteria better ex post than ex ante. Therefore, it makes sense to apply the standard ex ante
OCA criteria somewhat less stringently. If a country comes close but does not quite fully
meet the criteria ex ante, it should probably go ahead and join a currency union since the
odds are high that it would satisfy the criteria ex post” (Willett et al., 2010, p.851).
Consequently, it may be misleading to analyse the feasibility of currency areas only before
their start.
A vast literature has applied the structural VAR (SVAR) methodology to examine the
symmetry of shocks in Europe or in the US. Most of it embraces the years preceding the
EMU implementation and aims to assess its feasibility ex ante, thus encountering the critique
by Frankel and Rose (1998). Seminal papers in this literature are the ones by Bayoumi and
Eichengreen (1993, 1994), who use SVAR models identified with long-run restrictions in
order to compare supply and demand shocks across European countries and US regions.
Demand and supply shocks are recovered from the SVAR representation, relying on the
restriction that supply shocks have permanent effects on output, while demand shocks only
have temporary effects. Correlation coefficients of shocks between countries are then used to
evaluate the degree of similarity of business cycles. A number of subsequent papers followed
this approach: among them, Chamie et al. (1994), Ramos and Surinach (2004), Sato et al.
(2009), Zhang et al. (2004) split demand shocks into real and nominal ones to include either
monetary policy or exchange rates in the analysis. Chamie et al. (1994) decompose shocks
into a common and a specific component to measure their relative incidence on variables,
The nature and propagation of shocks in the euro area 97
while Ide and Moes (2003) distinguish between symmetric shocks, common to the euro
area, and asymmetric ones, specific to European countries.
The methodology proposed in this work to assess the symmetry and the propagation of
shocks across euro-area countries rests instead on sign restrictions (see, e.g., Canova and
De Nicoló, 2002; Uhlig, 2005; Peersman, 2005, 2011). This identification scheme provides
an alternative way of identifying structural shocks: sign restrictions require a minimal set
of economically meaningful restrictions for identifying shocks, in line with conventional
considerations. They avoid, by construction, anomalies such as the ‘price puzzle’. For the
purposes of this paper, they also allow overcoming a common problem in SVAR analyses,
that is, the eventual asymmetric responses of endogenous variables to the same kind of
shock, which would render problematic the interpretation of shocks’ correlations (Khai,
2009).
Compared with the existing SVAR literature adopting sign restrictions, this paper
analyses both the prevailing nature of macroeconomic shocks – whether idiosyncratic or
common – and their propagation mechanism to the economies. To investigate the first aspect,
it identifies structural shocks and compares their pairwise correlations between countries,
like done in SVARs models with long-run restrictions (Bayoumi and Eichengreen, 1993;
Sato et al., 2009; Zhang et al., 2004; Khai, 2009). To examine the second aspect, it calculates
the size of shocks and the speed of adjustment in response to shocks, in view of assessing
the degree of resilience of member countries prior and after the creation of the monetary
union.
Furthermore, in order to appraise the existence of a possible ‘EMU effect’, this work
splits the whole sample in relation to the start of the EMU. More specifically, it compares
shocks across three sub-samples, one preceding (1979:Q1–1998:Q4) and two following the
creation of the euro area (1999:Q1 onwards). In fact, the EMU period is itself divided into
two sub-samples (1999:Q1–2008:Q3 and 1999:Q1–2014:Q1), including or not the years of
the global financial crisis, in order to isolate its impact and to analyse the robustness of the
results.
This study offers a number of findings. First, focusing on the sample period prior to the
outbreak of the global financial crisis, the empirical evidence shows that aggregate supply,
demand and monetary policy shocks across euro-area countries increased significantly their
correlation after the adoption of the single currency (especially in the largest economies).
The increment was higher for monetary policy shocks, as we would expect given the
common monetary policy. The interpretation is that the EMU stimulated financial integration
and risk-sharing among member countries, and this, in turn, made macroeconomic shocks
more synchronised, even if some peripheral countries (Greece, Ireland, and to a lesser extent
Portugal) appeared to be laggard in catching up. A similar view is expressed by the European
Commission (2008) and by Mongelli (2008). Second, and related with, the propagation of
shocks to the economy, measured through the size and persistence, became less intense in
the 1999:Q1–2008:Q3 sub-sample (i.e., before the outbreak of the global financial crisis)
with respect to the pre-EMU period. Third, after the outbreak of the global financial crisis
(1999:Q1–2014:Q1 sub-sample), the scenario changed: the synchronisation of shocks was
even enhanced, but the magnitude of supply and demand shocks increased, in parallel with
the vulnerability of most euro-area countries. In this context, monetary policy measures
somewhat limited the volatility of interest rates.
The results of this paper are controlled by including in the analysis two countries
inside the European Union (EU) but outside the eurozone, such as the UK and Sweden.
It is confirmed that while before the crisis the increase in shock symmetry was higher
and the impact of shocks lower within euro-area countries than for the UK and Sweden,
the opposite took place after 2008:Q3, suggesting that the global financial crisis had a
remarkable negative impact, particularly on the euro area.
All in all, this analysis suggests that in the present juncture countries belonging to
the euro area do not appear homogeneous enough to face economic shocks through a
common policy response. Furthermore, the eurozone seems to miss some of the well known
preconditions necessary for forming and sustaining a currency area: in particular, labour
and prices are not fully flexible, business cycles do not appear to be enough synchronised,
and fiscal policies are constrained by high debt levels, especially in some countries. Against
this background, the prediction by Frankel and Rose (1998) according to which the euro
area alone would create endogenously the conditions for its success appears somehow
doubtful. On the contrary, the policy implications stemming from this analysis seem closer
to Krugman’s view (1993): the common monetary policy should be complemented with a
common fiscal policy in order to adjust regional imbalances caused by idiosyncratic shocks
or asymmetric responses to the common monetary policy. Clearly enough, it is hard to
persuade different countries to abandon another important piece of national sovereignty
in favour of a supranational (fiscal) authority, but at the current stage fostering European
integration represents the best solution to avoid the risk of a Europe “at two speeds” or,
even worse, the break-up of the eurozone.
The rest of the paper is structured as follows. The next section discusses the SVAR
specification and the identification strategy based on sign restrictions. Section 3 examines
the symmetry and the impact of shocks identified across countries and over different sample
periods. Section 4 focuses on the global financial crisis. The concluding remarks are in
Section 5.
2 The VAR model specification and identification with sign restrictions
Consider a reduced form VAR model with k lags:
yt = B(L)yt + ut , (1)
where yt is the (n × 1) vector of endogenous variables and B(L) = B1 L + B2 L2 + . . . +

Bk Lk is a polynomial matrix describing the impact of the k lagged endogenous variables
on their contemporaneous values. The vector of disturbances ut has the standard properties:
E(ut ) = 0, E(ut u′t ) = Σ, and E(ut u′t−s ) = 0 for s ̸= 0.
If all the roots of the polynomial matrix B1 z + B2 z 2 + . . . + Bk z k are strictly outside
the unit circle, then the VAR in equation (1) is stationary and possesses an infinite vector
moving average (VMA) representation:
yt = [In − B(L)]−1 ut = C(L)ut , (2)
where In is the identity matrix and the infinite-order matrix polynomial C(L) = C0 +
C1 L + C2 L2 + · · · represents the long-run responses of endogenous variables to correlated
disturbances ut . Being contemporaneously correlated, these latter disturbances incorporate
a common component to all variables included in the system, hence they do not have a
direct economic interpretation. In order to transform ut into instantaneously uncorrelated
‘structural shocks’ εt , the former need to be orthogonalised, that is, it has to be found a
matrix F such that:
ut = F εt , (3)
where E(εt ) = 0, E(εt ε′t ) = In , and E(εt ε′t−s ) = 0 for s ̸= 0. Based on equation (3), it
is possible to obtain the infinite structural-vector moving average (S-VMA) representation
of the reduced form VAR model in equation (1):
yt = [In − B(L)]−1 F εt = C(L)F εt = A(L)εt , (4)
where the infinite-order matrix polynomial A(L) = A0 + A1 L + A2 L2 + . . . describes the

long-run responses of endogenous variables to structural shocks. From equations (2)–(4) it
follows that:
A(L)εt = C(L)ut
or
A(L) = C(L)F. (5)
The relationship in equation (5) links the matrices describing permanent (A(L) and
C(L)) and contemporaneous (F ) relationships between variables and disturbances, and
clarifies the number of restrictions needed to identify the system. The system is closed
and identification is achieved by imposing n(n − 1)/2 identifying restrictions either on the
long-run polynomial matrix A(L) or on the short-run matrix F .
The traditional SVAR literature bases its identifying restrictions either on ad hoc
assumptions (e.g., triangular Cholesky decomposition of Σ) or on economic assumptions on
instantaneous or permanent relationships among structural shocks and endogenous variables
(short-run or long-run restrictions or a mix of the two). This latter identification technique
has become popular to study symmetry issues, starting from the cited study of Bayoumi
and Eichengreen (1993) who used long-run restrictions to estimate structural supply and
demand shocks.
More recently, the sign restrictions approach has been proposed as an alternative for
identifying structural shocks: this identification strategy is based on the direction (sign) of
the responses of the endogenous variables to structural shocks. A large body of literature
has claimed that sign restrictions provide some advantages compared with the traditional
just-identifying restrictions (i.e., the short-run and long-run restrictions). First, responses
based on just-identifying restrictions are only a single solution of a whole distribution of
all possible responses consistent with sign constraints. Second, just-identifying restrictions
may turn out to be too stringent in some empirical contexts: short-run restrictions are
often inconsistent with economic theory, while long-run restrictions, justified by the
classical neutrality assumption, may also result misleading (Galí, 1992, shows that in some
equilibrium models nominal shocks may have permanent effects on output due to a new
level of capital in steady-state. Faust and Leeper (1997) argue that long-run restrictions may
distort results in small samples).
Moreover, this paper adopts the sign restrictions approach because it allows
circumventing a potential problem of other identification techniques for the specific scope
of the analysis: in fact, in order to assess the degree of synchronisation of shocks across
countries, it is necessary that the responses of endogenous variables have the same direction
in each country. If the sign of the impulse responses to the same shock differed for two
countries, a high/low correlation would not correspond to lower/higher costs associated
with a currency area.
In this paper, the endogenous variables included in the yt vector in equation (1) are the
log of gross domestic product in first differences (output growth), the log of consumer price
index in first differences (inflation rate), and the 3-month interbank nominal interest rate
in levels. This choice of variables is the same as in Gerlach and Smets (1995), who use a
mix of short and long-run restrictions. In this context, some plausible predictions about the
impact effects of structural shocks are:
• Positive supply shocks reduce the price level and increase output.
• Positive demand shocks raise output and prices, thanks to price stickiness in the
short-run. The nominal interest rate is expected to react increasing.
• An expansionary monetary policy through a decrease of nominal interest rate rises
output and prices (and vice versa for a contractionary policy).
Technically, sign restrictions are implemented by generating a large number of randomly

orthonormal matrices Q:
Q′ Q = QQ′ = In . (6)
The orthogonal transformations of either Given or Householder can be used to draw Q.

Each time, the Q matrix is pre-multiplied by the Cholesky factor of the estimated variance-
covariance matrix of VAR residuals. For each generated Q, the response of endogenous
variables to the shocks can thus be calculated. If the sign of the response satisfies the
restrictions imposed on impact or in a specified number of constrained horizons, then the
draw is stored as valid, otherwise it is discarded (until a large number of draws compatible
with the sign restrictions is acquired). In this way, it is possible to obtain a large number of
series of orthogonal shocks and impulse responses corresponding to each valid draw. For
additional details on the implementation of the sign restrictions approach see Fry and Pagan
(2011).
3 Empirical results
Country-specific VAR models as in equation (1) are estimated for 11 euro-area countries,
separately: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the
Netherlands, Portugal, and Spain. Two VAR models are also estimated for the UK and
Sweden, which are two control countries inside the EU but outside the eurozone. In the
baseline country VAR model specifications, the lag order of the endogenous variables is set
to two.
The sources of the data, available on a quarterly basis from 1979:Q1 to 2014:Q1, are the
ECB Statistical Data Warehouse, Eurostat and Main Economic Indicators from the OECD
database. Since 1999, the 3-month interest rates for eurozone countries corresponds to the
3-month EURIBOR. For Germany, data through 1990 refers to the former territory of the
Federal Republic of Germany including West Berlin (West Germany), according to the
frontier status until 3 October, 1990.
Estimation is conducted using a Bayesian approach. Both the prior and the posterior
belong to the Normal-Inverted Wishart family. The implementation is as follows: a draw
from the Normal-Inverted Wishart posterior for the reduced form VAR parameters is taken.
A random orthonormal rotation matrix as in equation (6) is also generated and its transpose
pre-multiplied by the Cholesky decomposition of the variance-covariance matrix Σ. Impulse
response functions are then constructed. If the impulse responses to the three shocks are
jointly consistent with the imposed conditions, then the results are accepted. Otherwise,
the draw is rejected. Since sign restrictions are imposed on levels, for those variables taken
in first differences (output and prices) the restrictions are imposed on cumulated impulse
responses: cumulated responses of first differences give impulse responses of levels indeed.
In order to compare correlations of shocks and their size and persistence before and
after the EMU onset, VAR models are estimated separately for the 1979:Q1-1998:Q4 period
and for the period going from 1999:Q1 onwards. The first sub-sample, 1979:Q1–1998:Q4,
corresponds approximately to the start of the European Monetary System (EMS) and to
the pre-euro phase. The second sub-sample, from 1999:Q1 to 2008:Q3, coincides with the
third and final stage of the EMU. Notice that the sub-sample ends in 2008:Q3 – before the
failure of Lehman Brothers – in order to isolate the impact of the global financial crisis:
the influence of the financial crisis will be examined separately later on in Section 4, by
considering a third sub-sample: 1999:Q1-2014:Q1. For Greece, the two EMU sub-samples
start in 2001:Q1, given that this country adopted the euro only in 2001.
For each country examined, for each sub-sample considered (and for each accepted
draw) three series of structural shocks are recovered: supply, demand and monetary policy
shocks. Then, for each pair of countries, correlation coefficients between supply, demand,
and monetary policy shocks are computed. In this way two main aspects can be investigated:
• the symmetric or asymmetric nature of supply, demand, and monetary policy shocks,
examined through the pairwise correlation coefficients between countries
(Section 3.1);
• the propagation of shocks on endogenous variables, measured through the shock size
and persistence (or adjustment speed in response to shocks, see Section 3.2).
3.1 Correlation of shocks
This subsection focuses on correlations of shocks. The correlation of structural shocks

reveals if each shock has a predominant specific (asymmetric) or common (symmetric)
component: a positive correlation coefficient implies a prevailing symmetric component,
while a negative correlation suggests a prevailing asymmetric one (Horvath and Grabowski,
1997). According to the OCA theory, countries experiencing symmetric macroeconomic
shocks are likely to benefit of similar policy responses within the currency area.
Pairwise correlation coefficients measuring the association of supply, demand and
monetary policy shocks are computed for the 11 euro-area member countries plus the UK
and Sweden. Indeed, as anticipated, results are controlled by including two countries inside
the European Union (EU), but outside the eurozone. Tables 1–6 report pairwise correlation
coefficients between countries for each shock, considering the two sub-samples, before and
after the EMU start. Comparing correlation coefficients across different sub-samples allows
assessing whether shock symmetry has changed over time. In particular, Tables 1–3 refer
to the 1979:Q1–1998:Q4 sub-sample and to correlations of supply, demand, and monetary
policy shocks, respectively. Tables 4–6 refer to the 1999:Q1–2008:Q3 sub-sample and to
correlations of supply, demand, and monetary policy shocks.
Table 1 Correlation of structural SUPPLY shocks across countries, 1979:Q1–1998:Q4
AT BE DE ES FI FR GR IE IT NL PT SE UK
AT 1.00 0.30 0.30 0.05 0.09 0.07 0.11 0.19 0.07 0.23 0.06 0.01 0.16
BE 0.30 1.00 0.35 0.02 0.07 0.26 0.12 0.22 0.03 0.27 0.30 0.20 0.03
DE 0.30 0.35 1.00 –0.01 0.18 0.19 0.07 0.25 0.16 0.15 0.06 0.16 0.15
ES 0.05 0.02 –0.01 1.00 0.07 0.07 0.22 0.11 –0.02 0.01 0.29 0.14 0.13
FI 0.09 0.07 0.18 0.07 1.00 0.28 0.00 0.23 –0.03 –0.12 0.11 0.36 0.08
FR 0.07 0.26 0.19 0.07 0.28 1.00 0.19 0.21 0.23 0.23 0.30 0.28 0.18
GR 0.11 0.12 0.07 0.22 0.00 0.19 1.00 0.09 0.06 0.09 0.22 0.09 0.10
IE 0.19 0.22 0.25 0.11 0.23 0.21 0.09 1.00 –0.07 0.21 0.22 0.01 0.23
IT 0.07 0.03 0.16 –0.02 –0.03 0.23 0.06 –0.07 1.00 0.17 –0.13 0.26 –0.04
NL 0.23 0.27 0.15 0.01 –0.12 0.23 0.09 0.21 0.17 1.00 0.27 –0.08 0.17
PT 0.06 0.30 0.06 0.29 0.11 0.30 0.22 0.22 –0.13 0.27 1.00 0.13 0.08
SE 0.01 0.20 0.16 0.14 0.36 0.28 0.09 0.01 0.26 –0.08 0.13 1.00 –0.01
UK 0.16 0.03 0.15 0.13 0.08 0.18 0.10 0.23 –0.04 0.17 0.08 –0.01 1.00
Country codes: AT: Austria; BE: Belgium; DE: Germany; ES: Spain; FI: Finland; FR: France; GR:
Greece; IE: Ireland; IT: Italy; NL: Netherlands; PT: Portugal; SE: Sweden; UK: United Kingdom.
Table 2 Correlation of structural DEMAND shocks across countries, 1979:Q1–1998:Q4
AT 1.00 0.39 0.35 0.15 0.09 0.23 –0.05 0.03 0.28 0.37 0.10 0.05 0.24
BE 0.39 1.00 0.22 0.24 0.05 0.40 0.08 0.17 0.19 0.16 0.12 0.26 0.25
DE 0.35 0.22 1.00 0.18 –0.01 0.13 0.08 0.08 0.03 0.45 0.15 0.05 –0.04
ES 0.15 0.24 0.18 1.00 –0.01 0.25 0.10 0.07 0.01 0.22 0.28 0.17 –0.01
FI 0.09 0.05 –0.01 –0.01 1.00 0.08 –0.12 0.03 0.17 0.09 0.06 0.12 0.05
FR 0.23 0.40 0.13 0.25 0.08 1.00 –0.00 0.17 0.11 0.19 0.21 0.18 0.23
GR –0.05 0.08 0.08 0.10 –0.12 –0.00 1.00 0.04 –0.05 0.04 0.22 0.06 0.04
IE 0.03 0.17 0.08 0.07 0.03 0.17 0.04 1.00 0.04 –0.04 0.06 0.06 0.11
IT 0.28 0.19 0.03 0.01 0.17 0.11 –0.05 0.04 1.00 –0.01 0.02 0.24 0.23
NL 0.37 0.16 0.45 0.22 0.09 0.19 0.04 –0.04 –0.01 1.00 0.10 0.08 0.07
PT 0.10 0.12 0.15 0.28 0.06 0.21 0.22 0.06 0.02 0.10 1.00 0.06 0.20
SE 0.05 0.26 0.05 0.17 0.12 0.18 0.06 0.06 0.24 0.08 0.06 1.00 0.15
UK 0.24 0.25 –0.04 –0.01 0.05 0.23 0.04 0.11 0.23 0.07 0.20 0.15 1.00
Table 3 Correlation of structural MONETARY shocks across countries, 1979:Q1–1998:Q4
AT 1.00 0.30 0.31 0.09 –0.07 0.22 –0.07 0.22 0.07 0.35 0.00 –0.01 0.09
BE 0.30 1.00 0.31 0.03 –0.09 0.47 –0.01 0.26 0.15 0.31 –0.08 0.02 0.14
DE 0.31 0.31 1.00 –0.00 0.09 0.28 –0.01 0.08 0.06 0.25 0.01 0.25 0.09
ES 0.09 0.03 –0.00 1.00 –0.00 0.17 0.05 –0.01 0.00 0.17 0.32 0.04 –0.00
FI –0.07 –0.09 0.09 –0.00 1.00 0.05 –0.01 –0.08 0.05 0.09 0.01 0.34 0.21
FR 0.22 0.47 0.28 0.17 0.05 1.00 –0.01 0.33 0.16 0.29 0.07 0.14 0.09
GR –0.07 –0.01 –0.01 0.05 –0.01 –0.01 1.00 –0.07 –0.02 0.08 0.10 –0.04 –0.09
IE 0.22 0.26 0.08 –0.01 –0.08 0.33 –0.07 1.00 0.24 0.08 –0.10 –0.05 0.07
IT 0.07 0.15 0.06 0.00 0.05 0.16 –0.02 0.24 1.00 0.27 0.02 0.05 0.05
NL 0.35 0.31 0.25 0.17 0.09 0.29 0.08 0.08 0.27 1.00 –0.07 0.13 0.18
PT 0.00 –0.08 0.01 0.32 0.01 0.07 0.10 –0.10 0.02 –0.07 1.00 –0.07 –0.04
SE –0.01 0.02 0.25 0.04 0.34 0.14 –0.04 –0.05 0.05 0.13 –0.07 1.00 0.08
UK 0.09 0.14 0.09 –0.00 0.21 0.09 –0.09 0.07 0.05 0.18 –0.04 0.08 1.00
AT 1.00 0.39 0.39 0.38 0.21 0.44 –0.00 0.08 0.42 0.37 0.05 –0.04 0.28
BE 0.39 1.00 0.38 0.31 0.30 0.50 0.26 0.07 0.41 0.20 0.05 0.08 0.37
DE 0.39 0.38 1.00 0.41 0.14 0.39 0.34 0.05 0.42 0.23 –0.05 0.18 0.38
ES 0.38 0.31 0.41 1.00 0.26 0.34 0.32 0.09 0.44 0.30 0.38 –0.04 0.41
FI 0.21 0.30 0.14 0.26 1.00 0.47 0.08 0.35 0.29 0.27 0.06 0.23 0.28
FR 0.44 0.50 0.39 0.34 0.47 1.00 0.15 0.37 0.41 0.29 0.04 –0.11 0.39
GR –0.00 0.26 0.34 0.32 0.08 0.15 1.00 –0.31 0.40 0.05 0.02 0.16 0.33
IE 0.08 0.07 0.05 0.09 0.35 0.37 –0.31 1.00 –0.02 0.12 –0.11 –0.19 0.13
IT 0.42 0.41 0.42 0.44 0.29 0.41 0.40 –0.02 1.00 0.20 0.15 0.00 0.40
NL 0.37 0.20 0.23 0.30 0.27 0.29 0.05 0.12 0.20 1.00 0.18 0.17 0.27
PT 0.05 0.05 –0.05 0.38 0.06 0.04 0.02 –0.11 0.15 0.18 1.00 –0.04 0.04
SE –0.04 0.08 0.18 –0.04 0.23 –0.11 0.16 –0.19 0.00 0.17 –0.04 1.00 0.08
UK 0.28 0.37 0.38 0.41 0.28 0.39 0.33 0.13 0.40 0.27 0.04 0.08 1.00
For Greece, the sub-sample starts in 2001:Q1. Country codes: AT: Austria; BE: Belgium; DE:
Germany; ES: Spain; FI: Finland; FR: France; GR: Greece; IE: Ireland; IT: Italy; NL: Netherlands;
PT: Portugal; SE: Sweden; UK: United Kingdom.
In order to provide a precise and synthetic indicator of symmetry, the median of the
bootstrap distributions of pairwise correlation coefficients between pair of countries is
reported in each cell of the tables. For each pair of countries, 1000 bootstrap samples have
been generated.
AT 1.00 0.52 0.15 0.36 0.27 0.32 0.25 0.51 0.33 0.34 0.46 0.43 0.15
BE 0.52 1.00 0.30 0.26 0.39 0.43 0.23 0.57 0.50 0.43 0.52 0.29 0.30
DE 0.15 0.30 1.00 0.10 0.41 0.37 0.29 0.29 0.44 0.41 0.22 0.14 0.13
ES 0.36 0.26 0.10 1.00 0.26 0.33 0.28 0.38 0.28 0.26 0.24 0.26 0.20
FI 0.27 0.39 0.41 0.26 1.00 0.51 0.32 0.57 0.37 0.41 0.46 0.42 0.37
FR 0.32 0.43 0.37 0.33 0.51 1.00 0.45 0.47 0.45 0.46 0.32 0.33 0.30
GR 0.25 0.23 0.29 0.28 0.32 0.45 1.00 0.25 0.13 0.25 0.40 0.26 0.13
IE 0.51 0.57 0.29 0.38 0.57 0.47 0.25 1.00 0.45 0.60 0.50 0.47 0.37
IT 0.33 0.50 0.44 0.28 0.37 0.45 0.13 0.45 1.00 0.35 0.32 0.23 0.23
NL 0.34 0.43 0.41 0.26 0.41 0.46 0.25 0.60 0.35 1.00 0.37 0.36 0.30
PT 0.46 0.52 0.22 0.24 0.46 0.32 0.40 0.50 0.32 0.37 1.00 0.37 0.16
SE 0.43 0.29 0.14 0.26 0.42 0.33 0.26 0.47 0.23 0.36 0.37 1.00 0.02
UK 0.15 0.30 0.13 0.20 0.37 0.30 0.13 0.37 0.23 0.30 0.16 0.02 1.00
Table 6 Correlation of structural MONETARY shocks across countries, 1999:Q1–2008:Q3
AT 1.00 0.26 0.46 0.54 0.38 0.39 0.30 0.36 0.24 0.40 0.40 0.29 0.37
BE 0.26 1.00 0.43 0.39 0.12 0.45 0.29 0.20 0.52 0.24 0.42 0.17 0.16
DE 0.46 0.43 1.00 0.57 0.35 0.63 0.42 0.28 0.55 0.57 0.57 0.33 0.27
ES 0.54 0.39 0.57 1.00 0.33 0.46 0.45 0.41 0.44 0.37 0.59 0.34 0.36
FI 0.38 0.12 0.35 0.33 1.00 0.36 0.32 0.35 0.19 0.32 0.36 0.07 0.27
FR 0.39 0.45 0.63 0.46 0.36 1.00 0.45 0.14 0.54 0.49 0.50 0.21 0.23
GR 0.30 0.29 0.42 0.45 0.32 0.45 1.00 0.24 0.41 0.29 0.47 0.54 0.44
IE 0.36 0.20 0.28 0.41 0.35 0.14 0.24 1.00 0.19 0.25 0.44 0.27 0.36
IT 0.24 0.52 0.55 0.44 0.19 0.54 0.41 0.19 1.00 0.43 0.47 0.24 0.24
NL 0.40 0.24 0.57 0.37 0.32 0.49 0.29 0.25 0.43 1.00 0.48 0.33 0.31
PT 0.40 0.42 0.57 0.59 0.36 0.50 0.47 0.44 0.47 0.48 1.00 0.30 0.26
SE 0.29 0.17 0.33 0.34 0.07 0.21 0.54 0.27 0.24 0.33 0.30 1.00 0.30
UK 0.37 0.16 0.27 0.36 0.27 0.23 0.44 0.36 0.24 0.31 0.26 0.30 1.00
Concerning shock correlation, the overall picture is as follows:
• In the pre-EMU period (1979:Q1–1998:Q4), coefficients are mostly positive

(Tables 1–3). This result, which excludes large asymmetries between European
countries, is consistent with previous studies. In general, correlation is stronger
within a core group of European countries (Germany, France, Austria, Belgium and
the Netherlands). See also Verhoef (2003). On average, there is not much difference
in shocks correlations between euro-area and control countries. This holds true for all
three shocks.
• In the EMU period (1999:Q1–2008:Q3), correlation coefficients are always positive,
except in very few cases (Tables 4–6). Euro area countries display on average higher
correlations than Sweden and the UK. For the eurozone members, shock symmetry
largely increases compared to the previous sub-sample. Not surprisingly, given the
common monetary policy within the EMU, the highest increment is observed for the
correlation of monetary policy shocks. Correlations also increase for demand shocks
and, to a lesser extent, for supply shocks. These results support the claim that close
economic policy cooperation within the EU framework raised business cycle
comovement among member countries.
• In the EMU period, correlation increases more with respect to the pre-EMU for
euro-area countries than for the UK: correlation of monetary policy shocks increases
on average of 0.29 for euro-area countries, while it rises by 0.23 for the UK and by
0.21 for Sweden. For demand shocks, correlation increases on average of 0.24 for
euro-area countries, while it rises by 0.20 for Sweden and by 0.12 for the UK. For
supply shocks, the increase in correlation is lower for euro-area countries (from 0.14
to 0.23) than for the UK: in fact, shocks’ correlation with euro-area countries
increases by 0.18 for the UK (from 0.12 to 0.30), while it decreases for Sweden
(from 0.14 to 0.04).
Looking in more detail at single countries, some additional observations can be done. The
difference of correlation growth between euro-area countries and the two control ones is
more evident if we focus on the four main EMU economies (Germany, France, Italy and
Spain). Indeed, on average, correlation among the four main euro-area countries triples
compared to the previous sub-sample. This evidence also suggests that some member
countries in the euro area are latecomers in the process of integration. As a matter of fact,
aside a bulk of core countries whose shocks are most correlated, a group appears to be less
integrated, especially Greece, Ireland and to a lesser extent Portugal.
Overall, the evidence reported on shocks’ correlation provides mixed results about the
presence of some ‘EMU effect’: on the one hand, the integration and harmonisation imposed
on member countries made shocks to spread more homogeneously among them. To some
extent, this might support the thesis of Frankel and Rose (1998), according to which a
currency area would endogenously create the conditions of its success. Remarkably, it
is striking evident the difference between Finland and Sweden: before joining the euro,
Finland was not integrated at all with other European countries, while Sweden displayed
some positive correlation; after joining the euro area, the former experienced strong shocks
convergence with the other euro-area countries, differently from the neighbour Sweden. On
the other hand, the EMU does not seem to have fully fostered the process of convergence:
the distance between core and peripheral countries in the euro area – measured by the
differential between correlation coefficients – is fairly unchanged; in addition, correlation
of supply shocks, which are the most informative for the sustainability of a currency area
because signal the effectiveness of a ‘one fits all’ monetary policy, has grown the least, even
with respect to the UK (that is outside the eurozone).
3.2 Size and persistence of shocks
For the scope of the analysis, it is also crucial to examine the propagation of shocks through
their size and persistence. The size or magnitude of the shocks is equivalent to their impact
on endogenous variables, and it is measured through the impulse response coefficients at
different lags. In line with Bayoumi and Eichengreen (1993) and Zhang et al. (2004), the
impact of supply shock is measured by the response of output after 20 quarters, while the
impact of demand and monetary policy shocks is measured by the response of prices and
the nominal interest rate, respectively, after one year. If the magnitude of shocks is lower
in the sample including the EMU, this indicates a reduction of costs for countries joining
the currency area.
Tables 7 and 8 report size of the supply, demand and monetary policy shocks in the
two sub-samples, 1979:Q1–1998:Q4 and 1999:Q1–2008:Q3, respectively. The impact of
the shocks decreases or remains constant for all the euro-area countries during the EMU
period (especially that of supply shocks, which are the most worrying for the sustainability
of a currency area), with a single exception (demand shock in Finland). Monetary policy
shocks feature on average the smallest impact in 1999:Q1–2008:Q3, suggesting that the
monetary policy of the ECB succeeded to attenuate the volatility of market interest rates,
while the highest decrease can be observed for supply shocks. Overall, results highlight
that shocks have become less painful during the EMU, even though this might also be due
to the general tendency of lower volatility (Great Moderation) in the last decades: yet, the
comparison with the two control countries shows that the impact of macroeconomic shocks
has decreased as well, but of a lower amount.
Table 7 Size of shocks across countries, 1979:Q1–1998:Q4
GDP to agg. supply Inflation to agg. demand Int. rate to monetary policy
AT 0.50 0.33 0.19
BE 0.61 0.32 0.25
DE 0.53 0.50 0.14
ES 1.07 0.18 0.73
FI 1.50 0.28 0.61
FR 0.72 0.40 0.32
GR 0.76 0.89 0.35
IE 1.00 0.93 0.33
IT 0.83 0.66 0.17
NL 0.41 0.53 0.31
PT 1.48 0.55 0.40
SE 0.88 0.43 0.44
UK 1.26 0.30 0.26
Another important indicator is the adjustment speed in response to shocks (inverse of shocks
persistence), which is calculated as the share of the cumulated response after four quarters
over the long-run cumulated response (taken as the response after 20 quarters). Table 9 refers
to the pre-EMU sub-sample (1979:Q1–1998:Q4), while Table 10 pertains to 1999:Q1–
2008:Q3. A higher share implies a faster adjustment, and therefore, a lower cost for the
involved economy. In general, it is widely agreed that differences in the adjustment speed
across countries may be linked to different labour market characteristics and price rigidities.
AT 0.08 0.26 0.04
BE 0.07 0.27 0.09
DE 0.30 0.16 0.09
ES 0.10 0.19 0.15
FI 0.53 0.46 0.03
FR -0.03 0.09 0.11
GR 0.42 0.07 0.23
IE 0.66 0.49 0.08
IT 0.15 0.08 0.09
NL 0.22 0.18 0.07
PT 0.38 0.18 0.21
SE 0.96 0.18 0.15
UK 0.75 0.04 0.22
Table 9 Speed of adjustment of shocks across countries, 1979:Q1–1998:Q4
AT 0.18 0.09 0.45
BE 0.14 0.08 0.58
DE 0.20 0.07 0.51
ES 0.12 0.13 0.75
FI 0.12 0.30 0.55
FR 0.12 0.16 0.71
GR 0.25 0.12 0.31
IE 0.15 0.15 1.00
IT 0.11 0.14 0.91
NL 0.21 0.08 0.50
PT 0.13 0.12 0.53
SE 0.11 0.13 0.74
UK 0.09 0.10 0.69
On average, supply shocks are absorbed more rapidly during the EMU period in euro-area
countries than in the UK and in Sweden. In the UK the speed of adjustment of supply shocks
increases less than in the euro area, while it decreases in Sweden. Also for monetary policy
shocks, the adjustment becomes faster on average in the euro area, while both in Sweden
and in the UK monetary policy shocks become more persistent. Concerning demand shocks,
the speed of adjustment is slightly lower both for the euro area and for the two control
countries.
AT 0.43 0.12 0.70
BE 0.33 0.10 0.58
DE 0.20 0.09 0.74
ES 0.21 0.16 1.23
FI 0.13 0.10 1.00
FR 0.64 0.13 0.71
GR 0.23 0.12 0.48
IE 0.17 0.11 0.58
IT 0.26 0.07 0.72
NL 0.20 0.05 1.46
PT 0.21 0.10 0.44
SE 0.09 0.06 0.31
UK 0.16 0.08 0.48
In general, in the euro area demand shocks appear to be more persistent than supply shocks.
This might reflect some degree of price rigidity in the EMU.
4 The global financial crisis
So far, the analysis has focused on the first period of the EMU, before the outbreak of the
global financial crisis in 2008. The objective of this section is to investigate the impact of the
crisis. To this aim, shocks’ correlation, size and persistence are now calculated based on the
1999:Q1–2014:Q1 sub-sample and compared with those obtained in the pre-crisis period
1999:Q1–2008:Q3. Even if the crisis originated in USA in August 2007 (in the segment
of sub-prime mortgages), it involved seriously European countries in the fourth quarter of
2008, after the collapse of Lehman Brothers. In May 2010, it switched to a sovereign debt
crisis in some eurozone member states, while in the last years it involved more seriously
the real economy through a worrying deflationary process.
Tables 11–13 refer to average pairwise correlations in supply, demand, and monetary
policy shocks, respectively. Results show that during the crisis the average correlation of
demand and monetary policy shocks across euro-area countries further increases, while it
rises slightly less for the UK and Sweden. Correlation of supply shocks is broadly stable for
the UK and for euro-area countries, on average, while it somewhat increases for Sweden.
Recession and deflation have been a generalised phenomenon, and this can explain the
increase of co-movement both inside and outside the euro area.
AT 1.00 0.36 0.24 0.22 0.33 0.42 0.03 0.20 0.25 0.38 –0.07 0.04 0.18
BE 0.36 1.00 0.46 0.37 0.35 0.48 0.15 0.14 0.47 0.37 0.27 0.28 0.40
DE 0.24 0.46 1.00 0.34 0.11 0.43 0.11 0.00 0.48 0.27 0.08 0.21 0.28
ES 0.22 0.37 0.34 1.00 0.11 0.23 0.37 0.12 0.38 0.19 0.40 0.22 0.46
FI 0.33 0.35 0.11 0.11 1.00 0.35 –0.09 0.19 0.30 0.37 0.19 0.14 0.24
FR 0.42 0.48 0.43 0.23 0.35 1.00 0.08 0.32 0.44 0.41 0.02 0.05 0.25
GR 0.03 0.15 0.11 0.37 –0.09 0.08 1.00 –0.08 0.22 –0.04 0.27 0.23 0.23
IE 0.20 0.14 0.00 0.12 0.19 0.32 –0.08 1.00 0.06 0.14 –0.01 0.12 0.20
IT 0.25 0.47 0.48 0.38 0.30 0.44 0.22 0.06 1.00 0.43 0.36 0.19 0.35
NL 0.38 0.37 0.27 0.19 0.37 0.41 –0.04 0.14 0.43 1.00 0.18 0.11 0.07
PT –0.07 0.27 0.08 0.40 0.19 0.02 0.27 –0.01 0.36 0.18 1.00 0.28 0.29
SE 0.04 0.28 0.21 0.22 0.14 0.05 0.23 0.12 0.19 0.11 0.28 1.00 0.44
UK 0.18 0.40 0.28 0.46 0.24 0.25 0.23 0.20 0.35 0.07 0.29 0.44 1.00
AT 1.00 0.46 0.34 0.31 0.48 0.34 0.29 0.46 0.21 0.43 0.47 0.34 0.09
BE 0.46 1.00 0.57 0.24 0.49 0.48 0.37 0.45 0.48 0.35 0.52 0.38 0.40
DE 0.34 0.57 1.00 0.33 0.65 0.64 0.59 0.44 0.57 0.49 0.60 0.50 0.50
ES 0.31 0.24 0.33 1.00 0.41 0.40 0.39 0.37 0.29 0.37 0.38 0.27 0.29
FI 0.48 0.49 0.65 0.41 1.00 0.69 0.52 0.59 0.51 0.64 0.62 0.50 0.41
FR 0.34 0.48 0.64 0.40 0.69 1.00 0.60 0.51 0.51 0.55 0.58 0.39 0.42
GR 0.29 0.37 0.59 0.39 0.52 0.60 1.00 0.38 0.37 0.52 0.51 0.39 0.36
IE 0.46 0.45 0.44 0.37 0.59 0.51 0.38 1.00 0.48 0.55 0.53 0.44 0.35
IT 0.21 0.48 0.57 0.29 0.51 0.51 0.37 0.48 1.00 0.36 0.43 0.36 0.35
NL 0.43 0.35 0.49 0.37 0.64 0.55 0.52 0.55 0.36 1.00 0.49 0.49 0.27
PT 0.47 0.52 0.60 0.38 0.62 0.58 0.51 0.53 0.43 0.49 1.00 0.52 0.45
SE 0.34 0.38 0.50 0.27 0.50 0.39 0.39 0.44 0.36 0.49 0.52 1.00 0.27
UK 0.09 0.40 0.50 0.29 0.41 0.42 0.36 0.35 0.35 0.27 0.45 0.27 1.00
Table 14 reports the size of shocks during the crisis. Monetary policy shocks are the ones
with the lowest size. With respect to the 1999:Q1–2008:Q3 period, the impact of supply
and demand shocks increases in most of the eurozone countries, while that of monetary
policy shocks is, on average, almost unchanged. On the contrary, the impact of supply and
monetary shocks is lower in the UK and in Sweden, while the impact of demand shocks
increases as well, but slightly less than for the euro-area countries. In addition, shock sizes
appear in general to be more dispersed across euro-area countries than before the crisis,
showing a different degree of resilience between core and periphery to macroeconomic
shocks.
Table 13 Correlation of structural MONETARY shocks across countries 1999:Q1–2014:Q1
AT 1.00 0.57 0.57 0.64 0.54 0.62 0.37 0.53 0.52 0.60 0.53 0.38 0.42
BE 0.57 1.00 0.61 0.57 0.46 0.64 0.47 0.43 0.59 0.50 0.61 0.34 0.33
DE 0.57 0.61 1.00 0.53 0.63 0.68 0.43 0.47 0.66 0.61 0.61 0.29 0.40
ES 0.64 0.57 0.53 1.00 0.43 0.57 0.44 0.51 0.51 0.52 0.56 0.38 0.39
FI 0.54 0.46 0.63 0.43 1.00 0.59 0.47 0.45 0.53 0.49 0.52 0.23 0.29
FR 0.62 0.64 0.68 0.57 0.59 1.00 0.45 0.45 0.59 0.58 0.62 0.36 0.36
GR 0.37 0.47 0.43 0.44 0.47 0.45 1.00 0.49 0.44 0.49 0.53 0.56 0.46
IE 0.53 0.43 0.47 0.51 0.45 0.45 0.49 1.00 0.40 0.44 0.51 0.30 0.36
IT 0.52 0.59 0.66 0.51 0.53 0.59 0.44 0.40 1.00 0.52 0.62 0.30 0.36
NL 0.60 0.50 0.61 0.52 0.49 0.58 0.49 0.44 0.52 1.00 0.55 0.44 0.40
PT 0.53 0.61 0.61 0.56 0.52 0.62 0.53 0.51 0.62 0.55 1.00 0.39 0.37
SE 0.38 0.34 0.29 0.38 0.23 0.36 0.56 0.30 0.30 0.44 0.39 1.00 0.38
UK 0.42 0.33 0.40 0.39 0.29 0.36 0.46 0.36 0.36 0.40 0.37 0.38 1.00
AT 0.16 0.32 0.07
BE 0.13 0.45 0.09
DE 0.31 0.27 0.11
ES 0.26 0.34 0.13
FI 0.44 0.56 0.08
FR 0.08 0.20 0.10
GR 1.45 0.32 0.17
IE 0.66 0.85 0.13
IT 0.11 0.19 0.12
NL 0.30 0.19 0.09
PT 0.51 0.33 0.16
SE 0.86 0.32 0.11
UK 0.29 0.13 0.13
We now turn to the adjustment speed (Table 15). Monetary policy shocks are still the ones
with the lowest persistence, in the euro area as well as in the UK and Sweden, reflecting
the very low volatility of interest rates (due to the accommodative stance of central banks
that injected a lot of liquidity in the banking system). Table 15 also shows that the speed of
adjustment of shocks remains on average constant for eurozone countries, while it grows
both for the UK and for Sweden (particularly for monetary policy shocks and, to a lesser
extent, for demand shocks). As regards supply shocks, they become more persistent in most
countries of the eurozone, while they are constant in the UK and in Sweden.
AT 0.27 0.19 0.67
BE 0.27 0.19 0.56
DE 0.20 0.19 0.78
ES 0.13 0.27 1.44
FI 0.19 0.19 0.88
FR 0.34 0.25 0.77
GR 0.13 0.21 0.70
IE 0.14 0.31 0.83
IT 0.33 0.19 0.60
NL 0.22 0.13 0.96
PT 0.17 0.34 0.76
SE 0.08 0.23 0.82
UK 0.19 0.15 0.77
Overall, the results obtained in the global financial crisis sub-sample weaken the positive
indications found in the earlier period of the EMU, by showing signs of heterogeneity and
fragility in the euro area. The financial crisis increased the co-movement of demand and
monetary policy shocks across eurozone countries ‘on the downside’, as testified by the
higher average impact of shocks on the eurozone economies. At the same time, the empirical
evidence shows that after the crisis macroeconomic shocks have become more harmful
in terms of impact and persistence only for euro-area countries, but not for the UK and
Sweden, and exhibit an increased heterogeneity (especially for supply ones): this comes
at no surprise given that the crisis, starting from the financial sector, impaired seriously
the sovereign debt of several members of the eurozone and rapidly transmitted to the real
economy. The response of monetary authorities has been prompt and diversified (through
the so-called non standard monetary policy measures), but it is certainly more difficult to
manage economic policy responses in a currency area that lacks of political and fiscal unity
compared to single economies such as the UK and Sweden.
In this regard, the main policy lesson that can be drawn from the analysis of the
financial crisis period goes back to the mainstream literature on currency areas (Kenen,
1969; Krugman, 1993): the best solution to respond to economic shocks hitting a currency
area is to introduce a common monetary policy and a common fiscal policy in order to
adjust divergences in economic structures and business cycles of the member countries.
5 Concluding remarks
This paper has examined the nature and the propagation of macroeconomic shocks affecting
European countries before and after the EMU creation. The sustainability of a currency
area is to some extent related to the frequency and to the intensity of asymmetric shocks:
aggregate supply shocks in the form of not synchronised business cycles, aggregate demand,
and monetary policy shocks (these latter related to the asymmetric transmission of the
common monetary policy). Given that the formation of a currency area must be considered
an endogenous process, this paper has analysed its sustainability ex post and not ex ante,
focusing on the latest years of the EMU, which have been invested by the global financial
crisis.
Aggregate supply, demand, and monetary policy shocks have been identified through
sign restrictions before and after the EMU implementation for a large number of member
countries plus two control countries that are outside the EMU but inside the EU. Taken
together, these three shocks account for a large fraction of output fluctuations. Estimation has
been performed over different sub-samples, 1979:Q1–1998:Q4 and 1999:Q1 onwards: the
EMU period has itself been split into two sub-samples (1999:Q1–2008:Q3 and 1999:Q1–
2014:Q1) in order to assess the impact of the global financial crisis.
Results show that, prior to the financial crisis (1999:Q1–2008:Q3), shocks have become
overall more symmetric and less harmful for the eurozone countries, compared with the two
control countries. The analysis of the size of disturbances and of the speed of adjustment
reinforces the results obtained by applying the correlation analysis. The interpretation is
that the EMU, by favouring trade and integration of financial markets, has induced more
similarity and synchronisation of shocks in the euro area. Despite this, our analysis also
shows that some members appear to be latecomers in the process of integration, and that
business cycles synchronisation has not increased considerably (Degiannakis et al., 2014).
Results change in the latest years of the EMU, after the outbreak of the global financial
crisis (1999:Q1–2014:Q1): shock correlation has further increased during this period (at
least for monetary policy and demand shocks, less for supply shocks), but shocks have
become potentially more harmful for the euro-area economies, as testified by their larger
size and persistence relative to the two control countries. In addition, their impact appears to
be more heterogeneous across euro-area countries, showing a differentiation between core
and peripheral member states.
In terms of policy implications, these findings seem to encourage the view that, in
response to the crisis, relevant authorities and policy makers should not only implement a
common monetary policy – effective so far in dampening the volatility of interest rates –
but also tailor a more comprehensive set of economic policies that would require a high
degree of political and fiscal coordination.
Acknowledgements
While assuming scientific responsibility for any errors in the paper, the authors wish to
thank the Editors and two anonymous referees for their valuable comments. The authors are
also grateful to Christiane Baumeister, Romain Houssa, Gert Peersman, and Paul Reding
for useful suggestions and discussions. The views expressed herein are of the authors only
and do not necessarily reflect those of the Bank of Italy.
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The nature and propagation of shocks in the euro

Alberto Coco* and Andrea Silvestrini

Abstract: This paper investigates the nature and the propagation of

Reference to this paper should be made as follows: Coco, A. and Silvestrini, A.

Biographical notes: Alberto Coco is an Economist at the Market Operations

Andrea Silvestrini is an Economist at the Economic Outlook and Monetary Policy

Copyright © 2017 Inderscience Enterprises Ltd.

2 The VAR model specification and identification with sign restrictions

Consider a reduced form VAR model with k lags:

where yt is the (n × 1) vector of endogenous variables and B(L) = B1 L + B2 L2 + . . . +

yt = [In − B(L)]−1 ut = C(L)ut , (2)

yt = [In − B(L)]−1 F εt = C(L)F εt = A(L)εt , (4)

where the infinite-order matrix polynomial A(L) = A0 + A1 L + A2 L2 + . . . describes the

A(L) = C(L)F. (5)

Technically, sign restrictions are implemented by generating a large number of randomly

The orthogonal transformations of either Given or Householder can be used to draw Q.

3.1 Correlation of shocks

This subsection focuses on correlations of shocks. The correlation of structural shocks

Table 1 Correlation of structural SUPPLY shocks across countries, 1979:Q1–1998:Q4

Table 2 Correlation of structural DEMAND shocks across countries, 1979:Q1–1998:Q4

Table 4 Correlation of structural SUPPLY shocks across countries, 1999:Q1–2008:Q3

Table 6 Correlation of structural MONETARY shocks across countries, 1999:Q1–2008:Q3

Concerning shock correlation, the overall picture is as follows:

• In the pre-EMU period (1979:Q1–1998:Q4), coefficients are mostly positive

Table 7 Size of shocks across countries, 1979:Q1–1998:Q4

Table 8 Size of shocks across countries, 1999:Q1–2008:Q3

Table 9 Speed of adjustment of shocks across countries, 1979:Q1–1998:Q4

Table 10 Speed of adjustment of shocks across countries, 1999:Q1–2008:Q3

4 The global financial crisis

Table 12 Correlation of structural DEMAND shocks across countries, 1999:Q1–2014:Q1

Table 13 Correlation of structural MONETARY shocks across countries 1999:Q1–2014:Q1

Table 14 Size of shocks across countries, 1999:Q1–2014:Q1

Table 15 Speed of adjustment of shocks across countries, 1999:Q1–2014:Q1

Bayoumi, T. and Eichengreen, B. (1993) ‘Shocking aspects of European monetary integration’,

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