Common trends and cycles in European industrial production: Exchange rate regimes and economic convergence

We analyse monthly data on six European industrial production series to asc ertain the presence of common cycles and trends. Particular attention is pa id to the exchange rate regime, with the Bretton Woods and Exchange Rate Me chanism (ERM) regimes being analysed separately We employ recently develope d techniques in vector autoregressive (VAR) modelling (a) to test for and e stimate both common trends and common cycles, (b) to estimate VAR models su bject to these 'common feature' restrictions, (c) to compare and contrast t hese models with those obtained from an alternative approach, that of estim ating unrestricted levels VAR models, and (d) to present a permanent-transi tory decomposition of the series that is based on the common trends found i n the systems. We find limited evidence of convergence during the ERM, and this is of a long-run nature. In the short run, asymmetric shocks seem to h ave produced a divergence compared with the earlier Bretton Woods regime. T here is also some evidence of German 'leadership' over Belgium, France and the Netherlands.