The Fiscal Cliff and the Economy: Pointless, Painful Uncertainty
Everyone agrees uncertainty is bad for the economy. But doing something with this observation is seriously hampered by the fact that uncertainty is almost impossible to define and measure.
Many academics count things that proxy for uncertainty, such as mentions of the word in news articles. That’s one of the components in the uncertainty index developed by Scott R. Baker, Nicholas Bloom, and Steven J. Davis whose work we wrote about it here; it links heightened policy uncertainty to weaker growth. It’s also used by Jonathan Brogaard and Andrew Detzel here; they find increased policy uncertainty leads to lower stock prices and private investment.
Establishing causality is tricky. A weak economy or a traumatic event like a financial crisis or terrorist attacks will both raise uncertainty and provoke a policy response, but it’s the economic event, not the policy, that raises uncertainty and hurts growth.
I have my own back-of-the-envelope exercise. I count mentions of the word “uncertainty” in the Federal Reserve’s “beige book.” As my nearby chart shows, uncertainty has shot up in the last month. (Some months are blank because no beige book was released then.)
The beige book is a narrative based on conversations between analysts at the Fed and business contacts throughout the country. While this means it’s not well suited to quantitative analysis such as mine, it does allow you to isolate the source of the uncertainty.
Usually, it’s the economic or sales outlook. Often, it’s an event beyond America’s control: the European crisis, higher petrol prices, Japan’s tsunami, and so on. Some months, though, the source is clearly exogenous policy decisions. In April of 2011, the federal budget was cited in three of that month’s 15 references to uncertainty. Recall that that month the government was on the verge of shutting down over Republican pressure for cuts to discretionary spending. One reference was to the future of Fannie Mae and Freddie Mac.