Business cycle synchronization between the Western Balkans and the European Union

This paper investigates the degree of business cycle synchronization (BCS) between the Western Balkans and the European Union. While the degree of synchronization had been low or even negative before 2000, business cycles have clearly converged ever since. Since 2010, in particular, BCS with the EU has been high for all Western Balkan countries. In addition, this paper empirically tests which factors were responsible for the convergence process. Using a period-by-period correlation index for the time span from 1994 to 2013, we find that foreign trade is the most important positive contributor to business cycle convergence. Although fiscal differences are associated with negative BCS in the same year, our results suggest that they have a positive influence in subsequent periods. In contrast, we find that financial flows lead to business cycle decoupling because of their procyclical behavior in the respective domestic economy. The same relationship applies, according to our analysis, to remittances, whose impact on BCS is an underresearched topic in the empirical literature. We find that remittances from the EU to the Western Balkans behave similarly to financial flows, which supports the hypothesis that remittances are sent home to take advantage of favorable economic conditions.