Uncertainty and the Economy

October 5, 2012

Since the end of the most recent recession, the United States has been plagued with sluggish economic growth and high unemployment rate.  The weak economic recovery can be attributed to high levels of economic uncertainty, say Scott R. Baker, a Ph.D. candidate in the Stanford University Department of Economics, Nicholas Bloom, a professor in the Stanford University Department of Economics, and Steven J. Davis, deputy dean of the faculty and William H. Abbott professor of international business and economics at the University of Chicago Booth School of Business.

To qualify this claim, two things must be established: First, that economic policy uncertainty has been high. Second, that high levels of economic policy cause businesses and households to save rather than spend, invest and hire.

Baker, Bloom and Davis attempt to assess economic policy uncertainty and its role in economic performance. To assess the levels of economic policy uncertainty, an index was created that included:

  • The frequency of newspaper articles that contain terms related to economy, policy and uncertainty -- 10 newspapers were considered, including the New York Times, Wall Street Journal, Boston Globe and the Washington Post.
  • The frequency and importance of scheduled tax code expirations based on data from the Congressional Budget Office.
  • And finally, a look at disagreement about future inflation to look at the uncertainty of future purchase of goods and services by the government.

The findings show that economic policy uncertainty does affect economic conditions.

  • The most important sources of economic uncertainty stem from taxes, government spending and fiscal policy.
  • Policy uncertainty has been at historically high levels the past four years.
  • Furthermore, policy-related concerns account for a large share of overall economic uncertainty.
  • Finally, a rise in policy uncertainty is associated with lower levels of output and employment.

Source: Scott R. Baker, Nicholas Bloom and Steven J. Davis, "Uncertainty and the Economy," Hoover Institution, October 2, 2012.

 

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