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Financial Cycles and the Real Economy

Financial Cycles and the Real Economy

Lessons for CESEE Countries

Edited by Ewald Nowotny, Doris Ritzberger-Grünwald and Peter Backé

What is the link between the financial cycle - financial booms, followed by busts - and the real economy? What is the direction of this link and how salient is this connection? This unique book examines these fundamental questions and offers a paramount contribution to the debate surrounding the recent financial and economic crisis.

Chapter 6: Synchronization and decoupling of cycles in Slovenia

Boštjan Jazbec, Uroš Herman and Matija Lozej

Subjects: economics and finance, financial economics and regulation, money and banking


This chapter describes the experience of Slovenia regarding the synchronization of real and financial cycles with those of its main trading partners and the euro area. The period under consideration begins in 1995 and ends in mid-2013. It spans the period of accession to the European Union, the time around the adoption of the euro in 2007, as well as the subsequent periods of high growth and the recent crisis. For a small and highly open economy that is a member of a monetary union, synchronization of its business cycle with those of the other members of the monetary union is vital. Having a common monetary policy eliminates most of the exchange rate risk, provides an anchor for domestic prices, and eliminates idiosyncratic shocks that would be caused by having a different monetary policy than the main trading partners. However, not having an own monetary policy also means that one potential instrument for stabilization is missing. Here is where the synchronization of the business cycle plays the key role. If business cycles within the currency area are highly synchronized, then the area-wide reaction of monetary policy to shocks will be optimal for all members of the currency area. Nevertheless, a common currency could also lead to lower business cycle synchronization. If a country that experiences an idiosyncratic shock does not have an additional instrument for stabilisation, for example external devaluation, all the adjustment has to take place in the real economy, which can cause business cycle decoupling.

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