Analysis of spatial contiguity influences on state price level formation

Economists frequently ignore the spatial dimension of market activity, especially in macroeconomic analysis which tends to focus on aggregate variables. Using annual implicit price deflator time series for the 48 continental states, we carry out tests for the importance of geographic location in price-level determination. Spatial contiguity relationships between the states (geographic location) are shown to provide significant power in explaining historical variation in prices across states. The policy implications for local businesses trying to draw inferences regarding future price levels are that aggregate national information on the implicit price deflator (inflation) can be greatly enhanced by taking into account regional price-level information.