Policy uncertainty in the aftermath of economic crisis’ tends to slow recovery and suppress consumer spending
Financial turmoil, the Great Recession of 2007 to 2009, and the weak recovery that followed ushered in a period of heightened uncertainty in the United States. Even a year after the recession ended, Federal Reserve chairman Ben Bernanke described the economic outlook as “unusually uncertain.”
Many analysts claim that uncertainty about economic policies and their consequences has been an important factor slowing recovery. Uncertainty about taxes and the effects of policy on interest rates, prices, health costs, and other economic variables can lead households to defer consumer spending, and companies to cut back on capital investments, new product development, hiring, and worker training. Because new projects are expensive to reverse and because workers are costly to hire and fire, companies have an incentive to wait for greater political stability and policy certainty before proceeding with new business undertakings. If too many companies adopt a cautious stance in response to policy uncertainties, economic recovery may not take hold.
The price of policy uncertainty indeed could be high, according to a recent study titled, Measuring Economic Policy Uncertainty undertaken by me and Stanford University professor Nicholas Bloom. We developed a new index of policy-related economic uncertainty. The index reaches historically high levels after the Lehman Brothers bankruptcy and again over the past year in reaction to the eurozone crisis and the US debt ceiling impasse. We estimate that an increase in policy uncertainty of the size experienced from 2006 to 2011 leads to a fall in real Gross Domestic Product of 3.2%, a sharp drop in business investment spending of 16%, and a loss of about 2.3 million jobs.
The financial crisis and recession presented new and difficult challenges for policy makers. We believe that unusual policy challenges created by extraordinary economic disturbances were the main sources of elevated policy uncertainty in 2008 and 2009. The most threatening aspects of the financial crisis were contained by the middle of 2009, causing our policy uncertainty index to fall substantially in the latter part of 2009.
The index rises again in 2010 and 2011, however, reaching even higher levels than it did at the peak of the financial crisis. High levels of policy uncertainty in the past two years partly reflect deliberate policy choices and political gridlock. A clear example is the debt-ceiling dispute in the summer of 2011 between Democrats and Republicans, which created a real threat of a partial government shutdown. Congress eventually raised the debt ceiling, but agreement came at the last minute and with huge market volatility. Much of the high levels of policy uncertainty in 2011 were caused by policy decisions and policy maker conflicts over how to proceed.
Financial turmoil, the Great Recession of 2007 to 2009, and the weak recovery that followed ushered in a period of heightened uncertainty in the United States. Even a year after the recession ended, Federal Reserve chairman Ben Bernanke described the economic outlook as “unusually uncertain.”
Many analysts claim that uncertainty about economic policies and their consequences has been an important factor slowing recovery. Uncertainty about taxes and the effects of policy on interest rates, prices, health costs, and other economic variables can lead households to defer consumer spending, and companies to cut back on capital investments, new product development, hiring, and worker training. Because new projects are expensive to reverse and because workers are costly to hire and fire, companies have an incentive to wait for greater political stability and policy certainty before proceeding with new business undertakings. If too many companies adopt a cautious stance in response to policy uncertainties, economic recovery may not take hold.
The price of policy uncertainty indeed could be high, according to a recent study titled, Measuring Economic Policy Uncertainty undertaken by me and Stanford University professor Nicholas Bloom. We developed a new index of policy-related economic uncertainty. The index reaches historically high levels after the Lehman Brothers bankruptcy and again over the past year in reaction to the eurozone crisis and the US debt ceiling impasse. We estimate that an increase in policy uncertainty of the size experienced from 2006 to 2011 leads to a fall in real Gross Domestic Product of 3.2%, a sharp drop in business investment spending of 16%, and a loss of about 2.3 million jobs.
The financial crisis and recession presented new and difficult challenges for policy makers. We believe that unusual policy challenges created by extraordinary economic disturbances were the main sources of elevated policy uncertainty in 2008 and 2009. The most threatening aspects of the financial crisis were contained by the middle of 2009, causing our policy uncertainty index to fall substantially in the latter part of 2009.
The index rises again in 2010 and 2011, however, reaching even higher levels than it did at the peak of the financial crisis. High levels of policy uncertainty in the past two years partly reflect deliberate policy choices and political gridlock. A clear example is the debt-ceiling dispute in the summer of 2011 between Democrats and Republicans, which created a real threat of a partial government shutdown. Congress eventually raised the debt ceiling, but agreement came at the last minute and with huge market volatility. Much of the high levels of policy uncertainty in 2011 were caused by policy decisions and policy maker conflicts over how to proceed.
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