Linkages between the Eurozone and the South-Eastern European Countries: A Global VAR Analysis

Linkages between the Eurozone and the South-Eastern European Countries: A Global VAR Analysis

In the present paper we assess the impact of the Eurozone’s economic policies on specific South-Eastern European countries, namely Bulgaria, Croatia, Cyprus, Greece, Romania, Slovenia and Turkey.

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In the last two decades the world economy has experienced a number of fundamental changes, which radically altered the ways that economies function. The most important one is the high degree of interdependence among economies. Globalisation and free capital movements have resulted in a large degree of integration and interdependence of capital markets and the banking sector. These changes have led to an expansion of trade and of movements of production activities of multinational corporations. All these make imperative that the domestic economies should be studied from a global perspective. At the same time, at a regional level conditions have evolved to facilitate the response to these developments. This evolution has resulted in changes in the composition of output and movements of trade globally.

Concurrently, new and large economic players, like China, have emerged exercising an increasing influence around the world. The emerging economies have also become more integrated into the trade and financial markets, with the simultaneous increased patterns of regionalisation. The above changes may have altered in a fundamental way the magnitude of economic shocks, their duration and the way they are transmitted globally.

Most of the models that have been used for the study of domestic economies are not well-suited to investigate the global dimensions of these issues, and the way economies react to economic and financial interdependencies. Such problems are mostly investigated in many cases in an ad hoc manner and the models employed have not consistently incorporated suitable mechanisms to account for these. The models were of structural form, but in the last decades they have been displaced by vector autoregressive (VAR) models. The use of VARs and the subsequent cointegration analysis have resulted in long-run relations between various variables in the same economy, as suggested by economic theory. However, many long-run relations in one country may be influenced and affected by variables from other regions. One of the problems with the VAR methodology is that it works with a limited number of variables. But in order to incorporate a reasonable number of variables to account for global effects, large dimensionally system are required.

A very important step in this direction is the development of Global VAR (GVAR) modelling developed by Pesaran, Schuermann and Weiner (2004, henceforth PSW), which facilitated the study of international linkages. Their work has further expanded and evolved both at the theoretical and the empirical levels. For instance, Pesaran and Smith (2006) derived the VARX* models as the solution of dynamic stochastic general equilibrium model. 

An example of GVAR’s use on economic policy is the work by Pesaran, Smith and Smith (2005), in which they investigated what would have happened if the UK joined the euro in 1999. At the empirical level, the GVAR methodology has been used to examine the interdependencies of economies worldwide. Thus, it was used to investigate the changing degree of the dominance of the USA economy and its effect on other regions (Dées and Sain- Guilhem, 2009), the role of China and its increased influence around the world (Feldkircher and Korhonen, 2012), the linkages in the euro area (Dées, di Mauro, Pesaran and Smith, 2005), world trade flows (Bussiére, Chudik and Sestieri, 2012), and regional financial effects (Galesi and Sgherri, 2009).

In the present paper we investigate the impact of the Eurozone’s economic policies on specific economies of South-Eastern Europe, namely Bulgaria, Croatia, Cyprus, Greece, Romania, Slovenia and Turkey. The economic interdependence among these economies has been intensified during the last two decades, while all of them are with one way or another connected to the European Union (EU) and the Eurozone. For example, Bulgaria and Romania joined the EU in 2007 after a long transition period from centrally-planned to free market economies; Croatia will join the EU in 2013 having also followed a long transition period; Cyprus is a Eurozone member since 2008; Greece is a Eurozone member since 2001; Slovenia is a Eurozone member since 2007 and Turkey has settled a customs union with the EU in 1996 and is under negotiations for EU membership in the future. The latter country also had a stand-by agreement with the International Monetary Fund (IMF) for a number of years. Thus, there is a need of detailed investigation of the economic policies of the above countries, as well as the effects of the Eurozone policies. The GVAR model allows us to carry out this task, as it avoids all limitations that arise by the use of single VAR models and provides a consistent and flexible framework.

In brief, our results from the dynamic analysis indicate that the implementation of the Eurozone policies have similar effects on the economies of the countries under consideration, except for Turkey in the cases of real effective exchange rate and harmonised consumer price index. The same conclusion can be drawn regarding the effects of changes in the nominal exchange rate of the euro against the US dollar. 

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