Tuesday, 7 February 2012

Policy uncertainty - graph of the week

In today's VoxEU set of most recent articles, I ran into a very interesting one measuring economic policy uncertainty in the US as a way to explain the trails of the current recovery. 

Source: Baker, Bloom, Davis (2012) "Has Economic Uncertainty Hampered the Recovery"

Baker, Bloom and Davis (first two from Stanford, the third from Chicago) devised an economic policy uncertainty index based on three types of information: "frequency of newspaper articles referencing economic uncertainty and the role of policy, federal tax code provisions set to expire soon and the disagreement among forecasters on future inflation and future government spending." They have the index database, as well as their results and methodology explained on their webpage and this short paper for the Hoover Institution Press. Here's a good summary of what they're trying to say:
"We previously argued that policy uncertainty was a key factor stalling the recovery. When businesses are uncertain about taxes, healthcare costs and regulatory initiatives, they adopt a cautious stance. Because it is costly to make a hiring or investment mistake, many businesses naturally wait for calmer times to expand. If too many businesses wait to expand, the recovery never takes off. Weak investments in capital goods, product development and worker training also undermine longer-run growth." (Baker and Bloom, 2012, VoxEU)
They find very interesting correlations of the policy uncertainty index and economic outcomes. They also explain for the current set of good results of the US economy by noticing a sharp decrease of economic policy uncertainty in the past few months (the drop was 40% from its August 2011 peak to January 2012). 

Not surprisingly, the August peak is explained by the Congressional quarrels over the debt ceiling that brought to the historical S&P ratings downgrade. It was approximately the same time when the eurozone problems re-appeared. 

The current crisis was very often depicted as the crisis of confidence. This index fully reflects that as it can provide a good insight on the proper policy instrument to resolve the recession and kick-start the recovery. The most important finding is that whatever policy chosen, it should be done transparently and with an aim of boosting confidence. The less political implication, the better. 

6 comments:

  1. very interesting! this seems to be the genuine proof that political uncertainty is undermining the recovery..even though it would be even more interesting to see a longer time series to see how this index performed during the great depression

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    1. That would indeed be very interesting, but it requires a lot of 'manual labour' from the authors, as part of the index consists of going through newspaper articles and seeing how many of them talk about economic uncertainty.

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  2. I would venture that this uncertainty does not only manifest itself among the business community, but also among consumers. Who, right now, Is willing to make a major purchase when you are uncertain of your job or that your company will even survive?

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    1. Exactly! In the previous post on business cycle tracking, it can be seen that the consumer confidence index tends to follow the trajectory of the policy uncertainty index quite well.

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  3. now that's an indicator I would look into if I was an investor or a business owner!

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    1. Actually, this is what investors and business owners look at when making decisions – they hear the news everyday on the outcomes of the recovery and the responses of policymakers, so this makes them fully aware of the situation. With more ambiguity coming from policymakers, the worse are business expectations going to be.

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