Comovements and Heterogeneity in the Euro Area Analyzed in a Non-Stationary Dynamic Factor Model

Abstract

This paper establishes stylized facts on comovements and heterogeneity of individual euro-area countries' output and price developments in the past two decades. For this purpose, a non-stationary structural dynamic factor model is fit to a dataset of euro-area macroeconomic variables. The main results are as follows. Common permanent factors are important in explaining individual countries' output and price developments in the euro area. Output and prices are not only hit by permanent common, but also by permanent idiosyncratic shocks. The latter are mainly responsible for cross-country heterogeneity during most of the sample. The asymmetric transmission of common shocks plays a minor role; there is no strong evidence that some common shocks lead to greater cross-country heterogeneity than others.

Keywords: Dynamic factor models, sign restrictions, common trends, common cycles, international business cycles, EMU, output and inflation differentials, inflation persistence, monetary policy

JEL Classification: C3, E32, F00, E5