Policy Uncertainty Undermines Economic Recovery

February 22, 2013

Partisan gridlock and debates over the debt limit, spending and taxes send signals to Americans and businesspeople that the future of economic policy is uncertain. For an economic recovery, this uncertainty can slow economic growth and employment, says Nicholas Bloom, a professor of economics at Stanford University.

  • Though uncertainty is a subjective concept, Bloom created a proxy measure called Economic Policy Uncertainty (EPU). It indicates that uncertainty has increased and remained high since 2008.
  • The EPU measure quantifies newspaper coverage, expiring tax code provisions and disagreement about economic forecasts among the Philadelphia Federal Reserve's Survey of Professional Forecasters.
  • The indicator shows that tax, government spending and health care policy uncertainty are the main drivers of uncertainty since 2008, while monetary policy uncertainty has little effect, presumably because of stable inflation and low interest rates.

Policy uncertainty leads to forecasts of decreasing economic growth and employment in the future. The statistical model accounts for the effects of EPU factors, interest rates, inflation and stock-market levels on gross domestic product growth and employment.

  • The results indicate that the average increase in policy uncertainty between 2006 and 2011 led to a 2.5 percent drop in industrial production and 2.4 million fewer jobs in the United States.
  • The effects of uncertainty in the model are significant enough to give confidence to the findings.
  • Though it is hard to determine whether policy uncertainty precedes economic downturns or vice versa, a 2012 National Federation of Independent Business small firm survey reported that 35 percent of small firms complained about the uncertainty of government actions as a critical problem affecting future decisions.

Unfortunately, the upcoming policy agenda and political polarization suggests that policy uncertainty is likely to continue for some time. Upcoming debate over federal debts and deficits, health care and the debt ceiling limit indicate that the United States is likely to continue from one policy crisis to the next.

Redistricting has pitted members of the same party against each other, which in turn keeps politicians from moving to the middle between election cycles. The result is a lack of common ground, which will continue to make passing legislation difficult. Given the interdependent nature of the world economy, Blooms says that U.S. policy uncertainty will continue to affect economies worldwide.

Source: Nicholas Bloom, "Killing the Economic Engine: Is Policy Uncertainty Stalling U.S. and Canadian Economic Growth," Fraser Institute, February 2013.

 

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