Optimum Currency Area in the Eurozone. The regional origins of the European Business Cycle

In this study, we used a Bayesian dynamic factor model (BDFM) to examine the share of variance explained by the European and country factors for 59 regions in Eurozone countries in the period of 1992 to 2020. The BDFM output facilitated the construction of a criterion that enables the assessment of the cost of participation in the European Monetary Union, which is directly related to the optimum currency area theory. We found that in the 2005 to 2020 period, Spain was the only economy in which all regions were aligned with the European business cycle. Furthermore, over the examined period, we observed business cycle divergence with 42 regions experiencing a drop in the share of variance explained by the European factor. There is no evidence of convergence into clubs considering that the regions that are most in line with the European cycle experience the greatest drop in synchronization. These results contradict the predictions of "The European Commission View,” but do not provide any strong support for "The Krugman View.”