DP3746 Price Dispersions in Monetary Unions: The Role of Fiscal Shocks

Author(s): Fabio Canova, Evi Pappa
Publication Date: February 2003
Keyword(s): bayesian techniques, fiscal policy, price dispersions, supply effects
JEL(s): E30, H30
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3746

We study the effect of regional expenditure and revenue shocks on price dispersion in a monetary union using annual US state and quarterly EU data. We identify fiscal shocks using sign restrictions on the dynamics of expenditures, revenues, deficits and output. We construct two estimates for structural price dispersion dynamics, one for the average and one for each unit, which optimally weight the information contained in the data for all units. We find that fiscal shocks explain between 10-20% of the variability of price dispersion in the US and between 3-4% in the EU. On average, the predictions of standard theory are confirmed: expansionary fiscal disturbances produce positive price dispersion responses in both areas while distortionary balance budget shocks produce negative price responses. In about one third of the units, negative price dispersion responses to expansionary fiscal shocks are observed. Further, heterogeneities in shapes and peak responses are observed. Explanations for the puzzling features are provided.