Date of Award

6-2012

Document Type

Open Access

Degree Name

Bachelor of Arts

Department

Economics

First Advisor

Shelton Schmidt

Language

English

Abstract

The concern of a sovereign debt crisis in the euro zone has become particularly intense since 2010, as several countries’ sovereign debts have increased sharply due to bank bailouts. The Optimum Currency Area (OCA) theory suggests that countries that have close trade links, similar business cycles, labor mobility across the region, and a risk sharing system such as an automatic fiscal transfer mechanism are suitable candidates to form a common currency union. A study by Frankel and Rose (1998) claims that trade intensity and business cycles correlation are endogenous and strongly correlated. Hence, a country is more likely to satisfy the criteria for entry into a currency union “ex post” than “ex ante”. This paper aims to investigate the determinants of the correlation of business cycles in the euro zone. My hypothesis is that trade structure causes the convergence of business cycles, and only countries with similar trade structures are suitable candidates for a common monetary union. My regression model is based on the endogeneity hypothesis of the OCA criteria pioneered by Frankel and Rose (1998). The dataset is a time‐series panel data for 17 euro zone members from 2002‐2010. The dependent variable is business cycle correlation, and the independent variables include trade intensity, intra‐industry trade, and trade structure. The regression results suggest that trade structure heavily influences the correlation of business cycles, while intra‐industry trade has no direct impact on the correlation of business cycles.

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