Graph of the week: A crisis of confidence driven by policy decisions

Following up on the Economic policy uncertainty research done by Baker, Bloom and Davis (on which I wrote about earlier), here is a graph from them on the movements in the S&P 500 index:

Source: Baker, Bloom and Davis (2012) "Measuring Economic Policy Uncertainty" 

Notice how the majority of movements in the last period (both upwards and downwards) were policy-related. A possible conclusion from this could be that bad policy-making decisions (particularly towards the end of last year - see here, here and here) are the main drivers behind high levels of uncertainty. In the years during the crisis, it was obvious that other events were driving stock market swings much more than political decisions. But the sluggishness of the recovery can only be blamed on inadequate policy measures and misplaced signals sent by politicians to the market (such as the debt ceiling quarrel in August in America, or the eurozone faulty attempts to reform). 

On the methodological point, the way the authors come up with these movements is by reviewing newspaper articles, where they find an article that explains previous day movements. The 'movers' are alocated into categories such as macroeconomic variables (unemployment or GDP growth data), profit and earnings reports or policy-related movements such as announcements of new regulations, laws, or actions done by the FED, however excluding interest rate changes. Having to include for the FED interest rate decisions I would dare to say that policy oriented decisions would consist of an even larger part of the total movements (both upwards and downwards). 

The authors find the increase in the proportion of stock movements driven by policy decisions rather interesting: 

"...this does not seem to simply be a symptom of the recession. Looking at the other recessions in our sample, we see no jump in policy-related stock movements, with the large movements being driven primarily by macroeconomic data or, in the case of the 1990-1991 recession, by news of the first Gulf War. Plotting these numbers over time, you can see a tremendous surge in absolute numbers of large movements since 2007. Furthermore, the increase in policy-related movements, including European  and domestic policy-related events, is also apparent. The recent experience stands in stark contrast to the mid-1990s and the mid-2000s, where there were several years in a row without a single large stock movement of greater than 2.5% and even longer periods without a large movement driven by policy."

Point of the story - the crisis of confidence we experienced last year (and which is threatening to continue into 2012) had too much to do with politicians. It's never a good thing for businesses to eagerly anticipate what policy makers have to say before making allocation decisions. They should receive their signals elsewhere - among the consumers for example.

Read here about their further attempts of trying to make a new economic indicator of policy uncertainty.