International confidence spillovers and business cycles in small open economies

Abstract

The economic literature has for a long time been looking for explanations of a very strong international correlation of business cycles. This paper shows empirically that common fluctuations can to some degree be the effect of confidence shocks beeing transmitted internationally. We focus on a large (euro area) and a small, nearby economy (Poland). Our results show that euro area confidence fluctuations account for approximately 40-70% of business cycle fluctuations both in the euro area and in Poland. More importantly, their transmission happens not only via traditional channels (e.g. by confidence affecting euro area GDP and then Polish GDP via trade), but to a large extent occurs directly (e.g. by news spreading via media).