Thursday, May 24, 2012

How integrated are Eastern and Western Europe now?

25 years ago, it was very rare to see a car with Eastern European plates in Western Europe. Now, they are all over the place, including trucks (why are there so many from Romania?). This is a clear indication, even if you ignore history, that the East-West integration is stronger than it has been for a long time. But there are more aspects to integration than the movement of cars.

Catherine and Klaus Prettner basically look whether the two regions are cointegrated. They build two national aggregates, one with 12 European Community countries (unfortunately no UK) and 5 Central European countries. Using a vector error-correction model with restrictions from a standard open-economy business-cycle model with cash-in-advance. Output shocks to one area spill over to the other, surprisingly in similar magnitudes in both directions. Interest rate shocks are expectedly asymmetric though: West impacts East, but East does not impact West. But given that all this has been in transition mode over the 1995-2009 sample, I really wonder how these impacts have changed over time. A framework with time varying coefficients would have been helpful here.

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