Paper #923

Title:

Price differentials in monetary unions: The role of fiscal shocks

Authors:

Fabio Canova and Evi Pappa

Date:

June 2003 (Revised: June 2005)

Abstract:

We study the effect of regional expenditure and revenue shocks on price differentials for 47 US states and 9 EU countries. We identify shocks using sign restrictions on the dynamics of deficits and output and construct two estimates for structural price differentials dynamics which optimally weight the information contained in the data for all units. Fiscal shocks explain between 14 and 23 percent of the variability of price differentials both in the US and in the EU. On average, expansionary fiscal disturbances produce positive price differential responses while distortionary balance budget shocks produce negative price differential responses. In a number of units, price differential responses to expansionary fiscal shocks are negative. Spillovers and labor supply effects partially explain this pattern while geographical, political, and economic indicators do not.

Keywords:

Price differentials, Fiscal policy, Monetary unions, Bayesian methods

JEL codes:

E3, E5, H7

Area of Research:

Macroeconomics and International Economics

Published in:

The Economic Journal, 117(520), 2007, 713-737

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