Fiscal divergence and business cycle synchronization: irresponsibility is idiosyncratic.
Using panels of 115 countries of world - including 21 OECD countries - and 40 years of annual data, the authors find that countries with similar government budget positions tend to have business cycles that fluctuate more closely. Thus fiscal convergence (in the form of persistently similar ratios of government surplus/deficit to GDP) is systematically associated with more strongly synchronized business cycles. Evidence is also found that reduced fiscal deficits increase business-cycle synchronization. The Maastricht 'convergence criteria', used to determine eligibility for EMU, encouraged fiscal convergence and deficit reduction. So they may, indirectly, have moved Europe closer to an optimum currency area, by reducing countries' abilities to create idiosyncratic fiscal shocks. The empirical results of the study are economically and statistically significant, and robust.
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