Federal policies and local economies: Europe and the US

This paper establishes stylized facts on regional output fluctuations in Eu rope and the US. Moreover, it proposes a measure of the potential output ta rget of the future European central bank, estimates the potential variance stabilization of a fiscal federation and constructs a regional map of the p otential beneficiaries of monetary and fiscal federal policies. The econome tric model is an extention of the dynamic factor model a la Sargent and Sim s (1977. In: Sims, C.A. (Ed.), New Methods in Business Research. Federal Re serve Bank of Minneapolis) where we introduce an intermediate-level shock, which is common to all regions (counties) in each country (state), but it i s not common to Europe (US) as a whole. We build on Forni and Reichlin (199 6. Empirical Economics, Long-Run Economic Growth (special issue) 21 (1996) 27-42. Review of Economic Studies 65 (1998) 453-473) to propose an estimati on method which exploits the large cross-sectional dimension of our data se t. Our analysis shows that (i) Europe has a level of integration similar to that of the US and that national shocks are not a sizeable source of fluct uations: around 75% of output variance is explained by global and purely lo cal dynamics; (ii) Europe, unlike the US, has no traditional business cycle ; (iii) the core of the most integrated regions in Europe does not have nat ional boundaries;(iv) the future European Central Bank has a potential stab ilization target of about 18% of total output fluctuations; (v) a fiscal fe deration, if implemented, could have a smoothing effect on output in additi on to what done by national fiscal policy, which accounts also for about 18 % of total output fluctuations. (C) 2001 Elsevier Science B.V. All rights r eserved. JEL classification: C51; E32; O30.