RDP 2004-09: Co-Movement of Australian State Business Cycles 6. Conclusion

Our goal in this paper has been to disentangle the common and idiosyncratic fluctuations which drive state cyclical activity in Australia, and to trace their paths through the economy. We have used a variety of statistical techniques to achieve this. A number of common conclusions arise from the different techniques. State business cycles tend to co-move quite strongly, particularly those of the larger states (NSW, Vic and Q1d). This is perhaps not surprising, given all states share a common monetary policy and exchange rate. Correlations between state business cycles (using SFD as a measure of activity) are similar to those found in regional studies of other countries, and suggest the presence of a significant contemporaneous relationship. Concordance measures and comparisons of recession periods both support these findings.

A more detailed analysis suggests that this co-movement arises mainly from a pronounced common cycle, which affects all states simultaneously. This common cycle is presumably driven by macroeconomic shocks such as fluctuations in the exchange rate or the terms of trade. Spillovers of idiosyncratic shocks from one state to another through trade and investment linkages appear less important in explaining co-movement. Lagged correlations between state cycles are generally not larger than contemporaneous correlations, and there is only modest evidence that cyclical activity in one state Granger-causes activity in other states.

Using an unobserved components model, we find evidence that common shocks play the major role in shaping state activity, followed by idiosyncratic shocks, with spillovers of shocks between states the least important. Idiosyncratic shocks may play a relatively greater role in shaping the cycles of the smaller states, but simulations of shock responses suggest that the cumulative impact of a common shock is larger (even in these states) than an idiosyncratic shock of comparable size. Overall, while the lack of a long time series of state data makes it difficult to be definitive, our various approaches all suggest that state business cycles move quite closely together in Australia, and that common shocks are the most important source of fluctuations in state economic activity.