Policy uncertainty and employment

from "Economic Policy Uncertainty and Small Business Expansion" by Mark E. Schweitzer and Scott Shane in the Fed of Cleveland Economic Commentary

 The policy uncertainty measure is also a monthly measure. It contains three components. According to its creators: “One component quantifies newspaper coverage of policy-related economic uncertainty. A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among economic forecasters as a proxy for uncertainty.”

The components are weighted as follows: 50 percent on the news component and 16.67 percent each on tax expirations, forecaster disagreement about the future CPI, and forecaster disagreement about future federal expenditures.

We believe that the Baker, Bloom, and Davis measure accurately captures policy uncertainty for several reasons. First, it looks reasonable. The measure increases in response to events that most observers believe have increased policy uncertainty and decreases in response to events that most observers think reduced that uncertainty. In addition, the authors show that other measures developed using the same approach accurately predict other types of uncertainty, such as financial uncertainty. Finally, the measure predicts changes in several measures of economic activity, such as employment and GDP.

The uncertainty index provides a good measure of what risks businesses and investors are facing at this time. This uncertainty story that business have avoided investing has been an argument that has been used for some time but has not been quantified. If there is a high degree of disagreement, then there is less likely to be investment funds committed. The uncertainty is often associated with key risk periods but the index shows an extremely high level over the last three years and has not fallen like other periods of uncertainty.

The persistence of uncertainty is creating a global drag on employment and investment markets. This will only be cleared up if there more focused policy proposals.