Uncertainty and the Economy

[Valin]

Policy Review :

Scott R. Baker; Nicholas Bloom; and Steven J. Davis

10/2/12

 

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The u.s. economy hit bottom in June 2009. Thirty months later, output growth remains sluggish and unemployment still hovers above 8 percent. A critical question is why. One view attributes the weak recovery, at least in part, to high levels of uncertainty about economic policy. This view entails two claims: First, that economic policy uncertainty has been unusually high in recent years. Second, that high levels of economic policy uncertainty caused households and businesses to hold back significantly on spending, investment, and hiring. We take a look at both claims in this article.

 

 

We start by considering an index of economic policy uncertainty developed in our 2012 paper “Measuring Economic Policy Uncertainty.” Figure 1, which plots our index, indicates that economic policy uncertainty fluctuates strongly over time. The index shows historically high levels of economic policy uncertainty in the last four years. It reached an all-time peak in August 2011.

 

As discussed below, we also find evidence that policy concerns account for an unusually high share of overall economic uncertainty in recent years. Moreover, short-term movements in overall economic uncertainty more closely track movements in policy-related uncertainty in the past decade than in earlier periods. In short, our analysis provides considerable support for the first claim of the policy uncertainty view.

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