Laura Ioana Bidea, I6032946, EEP

Topic 1 Eurozone enlargement: The Romanian Scenario Classical article: Julius Horvath, Optimum currency area theory: a selective review (2003) rather than being a classical article in itself, it comprises a comprehensive collection of all classical theories in the OCA research area: Mundell (1961) assessed different asymmetric shocks and made the argument that the optimum currency areas are identical with economic regions, when defined by inter-regional labor mobility. According to Mundell, the argument for flexible exchange rates depends on the degree to which countries correspond to regions. If a nation is an economic region with internal factor mobility and external factor immobility, the argument for flexible exchange rates holds. If nations are dissimilar to regions, fixed exchange rates may do as well as flexible exchange rates. Kenen (1969) challenges Mundells definition of region, which suggests that an optimum currency area has to be small (according to Kenen, because of the homogeneity of the labor force it is impossible to delineate a region over which there is perfect mobility. He also suggests the product diversification as a characteristic for optimum currency areas (a well-diversified economy will rarely confront changes in demand for the exports). McKinnon (1963) considers the openness of the economy, defined as the ratio of tradables to non-tradables, as the most important criteria of optimum currency area. Recent articles 1) Convergence and shocks in the road to EU: Empirical investigations for Bulgaria and Romania, Jean-Marc Figuet and Nikolay Nenovsky (2005) The empirical article aims at measuring the convergence of Romania and Bulgaria with the euro zone (the empirical investigation of the convergence state is of current interest, especially in the light shed by the recent events, which have shown underlying disfunctionalities among eurozone members). According to the review of the empirical research on the correlation of business cycles in the post-communist countries done by Fidrmuc and Korhonen (2004), Romania has only been included in 3 out of 27 surveys. More analysis exist, such as Brada and Kutan (2001, 2002), De Grauwe and Schnabl (2004), Suepell (2003), Bolle and Blessing (2005), but they are not too focused on Romania. Figuet and Nenovsky present the state of convergence (unconditional convergence) using a panel model and the presence of long-term relations (through the method of cointegration) between the macroeconomic variables grouped as nominal, real and financial. They also evaluate

Laura Ioana Bidea, I6032946, EEP

the reactions of the Romanian and Bulgarian economies to external shocks, using VAR methodology, over the period mid 1997-mid 2005, quarterly data. The model reduces nominal convergence to nominal income, price level, inflation and money supply (M1), real convergence to real income and productivity and the financial convergence to domestic credit in the private sector, behavior of the interest rates on deposits and interest spread. The shocks are reduced to demand side shocks (real income), monetary policy shocks (interest rates), shocks in the real exchange rate or price differential. The shock responses are evaluated in the frame of the VAR models (impulse response). The tests show no convergence whatsoever in Romania, while little convergence in Bulgaria and strong convergence in Hungary and Czech Republic. The simulation of shocks showed that the Romanian economy is cut off from the European business cycle. 2) Enlargement and Eurozone: Convergence or Divergence?, Minoas Koukouritakis, Leo Michelis (2005) The article is threefold: it analyses the cointegrating relations among the nominal exchange rates, inflation rates, long-term interest rates, deficits and debts of the 10 countries that became EU members in 2004; it analyses the long-run cointegration properties of real exchange rates and real per capita GDPs among the same countries; it identifies, estimates and tests the trends that lead to permanent changes in each group of variables. Further research direction: Starting off from the above mentioned models, expand the data until 2011 and assess whether the situation has changed (not only for Romania, but also for the other countries of the panel). Problem statement: To what extent has the Romanian real and nominal convergence evolved until 2011? What were the underlying causes and what are the possible prescriptions?

Topic 2 Animal spirits at play within the economy Comparative study for selected EU countries Classical articles: 1) Costas Azariadis, Self-fulfilling prophecies (1981): Azariadis performs a highly mathematical proof of the fact that business cycles are influenced by any subjective factor agents consider relevant; thus, prices change simply because they are expected to and price signals convey no structural information (he also mentions a few historical cases: the Dutch tulip mania, the South Sea bubble in England and the collapse of the Mississippi Company in France all of which are not considered justified by objective or

Laura Ioana Bidea, I6032946, EEP

fundamental conditions. In the end, he proves that a paradoxal behavior, which he names extraneous uncertainty is both possible and probable among rational expectations equilibria in an aggregative model of overlapping generations. He constrains the price level to clear markets, reproduce beliefs and to follow a two-state Markov process, and finds out that a significant fraction of the resulting equilibria is plagued with extraneous uncertainty. Recent articles: 1) Joseph Bafumi, Animal spirits: the effect of economic expectations on economic output, Applied Economics (2011) Empirical evidence exists to challenge the traditional claim that the economic agents engage in rational expectations and are able forecasters of future economic performance. More than just predicting economic output, economic agents can actually influence it through their self-fulfilling behavior. After controlling for rational expectations, how much of the variability of output can be explained by economic emotions? In the self-fulfilling prophecy, predictions are not conditional on any information, unlike the rational expectations, where predictions are based on a rational understanding of processes and variables. Matusaka and Sdordone (1995) find that economic sentiment significantly predicts economic performance after controlling for some variables, but their study fails to incorporate additional sources of information that can inform the public, weakening the self-fulfilling prophecy theory. Empirical work cannot easily discern between rational expectations and the self-fulfilling prophecy. Bafumi aims at excluding rational expectations as much as possible from the forecasts, control for it and test for the remaining effect of prospective sentiments on economic output (his result is that, on average, about one-fifth of the variability of economic output can be explained by sentiment). More precisely, Bafumi tests the ability of the public to predict economic output after controlling for economic indicators, the past economy and expert forecasts, all three of which serve as a proxy for rational expectations. 2) Marcelle Chauvet, Sunpots, animal spirits and economic fluctuations (2000) In his paper, Chauvet researches empirically the interrelations between waves of optimism and pessimism and subsequent economic fluctuations in the US economy, focusing on the behavior of non-fundamental movements in consumer sentiment, as a proxy for consumers sunspots and in business formation, representing investors animal spirit. For measuring consumer expectations, Chauvet uses the University of Michigan Index of Consumer Sentiment, constructed based on consumers responses to survey questions regarding current and expected economic conditions. After also using the index of net business formation to measure investors

Laura Ioana Bidea, I6032946, EEP

expectations, Chauvet estimates vector autoregressions including GDP, consumer sentiment index, and variables that reflect information of fundamentals, taking off from Fuhrer (1993), Matsusaka and Sbordone (1995), finding that sentiment plays a nontrivial role in affecting variations in economic activity even after controlling for fundamentals. Further research direction: Starting off from the above mentioned models, with data collected for a selection of countries from both Northern and Southern European countries. After having obtained the correlation between the extent at which animal spirits impact the economy and the actual economic indicators, are there any lessons that could be learned from the best performers in the field? Problem statement: How do animal spirits influence the variability of economic output in Northern versus Southern countries?