The Uncertainty About Uncertainty

The Uncertainty About Uncertainty

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The debate over policy uncertainty’s effect on the economy breaks down along ideological lines.

Leading Republicans and their economic advisers say the uncertain economic environment created by President’s Obama’s push for higher taxes on the rich and stricter banking regulations is forcing businesses across America to sit on their hands rather than invest and create new jobs. “Job creators in America basically are on strike,” House Speaker John Boehner, R-Ohio, told the Washington Economics Club last fall.

New York Times columnist and Nobel Prize-winning economist Paul Krugman is the leading skeptic about such claims. He calls it a belief in “the confidence fairy.” Writing last April about Europe’s turn to austerity in the face of its fiscal woes, he opined that “appeals to the wonders of confidence are something Herbert Hoover would have found completely familiar — and faith in the confidence fairy has worked out about as well for modern Europe as it did for Hoover’s America.”

The confidence debate reemerged last week in an op-ed in the Wall Street Journal by Columbia Business School dean Glenn Hubbard, who also is a leading adviser to Republican candidate Mitt Romney.
“Uncertainty over policy – particularly over tax and regulatory policy – slowed the recovery and limited job creation,” he wrote. Growth would have been 1.4 percentage points higher last year and there would have been 2.3 million more jobs in just the last 18 months if confidence had returned to “pre-crisis levels, he claimed.

Hubbard cited the recent work of a trio of academic economists, who have even launched their own “policy uncertainty” website. But while they agree uncertainty tracks fairly closely with economic activity over the decades, it isn’t clear what causes what: Is policy uncertainty causing a bad economy or is a bad economy causing policy uncertainty? “I certainly wouldn’t argue causation,” said Nicholas Bloom of Stanford University, who co-authored a recent paper on the topic. 

Half of the policy uncertainty index that Bloom helped create is based on articles in ten leading newspapers that mention words like “economy,” “uncertainty,” “policy,” “regulation” and “deficit.” The other half is based on variations on issues like expiring tax code provisions, forecaster disagreements on inflation and government purchasing projections.

By tracking those variables back to the 1980s, the index showed that policy uncertainty is as likely to peak during times of political stress as during economic stress. So, for instance, the index spiked upward after the 1987 crash and during the 1998 Russian/Long Term Capital Management crisis. But it also surged during the first Gulf War and when President Clinton was elected and hit a pre-Great Recession highs after 9/11. 

But the past few years of economic turmoil have seen huge spikes in the index, dwarfing those earlier periods of political stress. In late 2008, after the collapse Lehman Brothers and the enactment of the Toxic Assets Relief Program, policy uncertainty hit what briefly was an all-time high. While it dropped back in 2009, it spiked again to its all-time high during the debt ceiling debate in the summer of 2011. Though it has since fallen back, the index has remained fairly high this year.

Bloom said policy uncertainty was more likely to have long-term effects rather than short-term effects on economic activity. When companies “sit on their hands,” they are more likely to cut back on research and development and postpone investments in information technology and new capital equipment. They are less likely to cut workers who supply the markets they already have.

Because of the high levels of uncertainty since the 2008-9 collapse, the U.S. has seen four years of capital underinvestment. “That could have very negative consequences long-term for the economy,” he said.
“Policy uncertainty is a factor in the economy, but it’s not the only factor,” Bloom said. “And while I agree it’s a serious drag on the economy, it’s not clear to me which party is responsible.”

spent 25 years as a foreign correspondent, economics writer and investigative business reporter for the Chicago Tribune and other publications. He is the author of the 2004 book, The $800 Million Pill: The Truth Behind the Cost of New Drugs.