Tuesday, April 7, 2020

Uncertainty and the COVID-19 recession - It is all about the uncertainty



What will be the impact on US economic growth from the COVID-19 pandemic? This is not an easy problem since we have limited history to make any comparisons or projections; however, it is still important to try and provide some figures to guide policy and investment decisions. A new forecast has been generated by Scott Baker, Nick Bloom, Steve Davis and Stephen Terry in their just released paper "COVID-Induced Economic Uncertainty"The authors are known for their construction of uncertainty indices. We have been avid follower of these uncertainty indices and tools and think this is a fruitful direction for forecasting.

The novel approach is to use real time uncertainty indices and a disaster analysis model to generate their forecast estimates. The authors use stock market volatility, newspaper-based economic uncertainty, and subjective uncertainty from business surveys taken through March along with a model that has looked at past disasters to generate their VAR (vector autoregression) forecasts. They are looking at a decline of 11% GDP by 2020:4 with a 90% confidence level. 

Clearly, these numbers can change as we receive more information, but their focus is timely and emphasis is on what may be the most important current factor, uncertainty. They estimate that 60% of the decline will be uncertainty induced. Uncertainty causes fear, creates a demand for holding cash, and kills the animal spirits of optimism that often drive investment decisions. In an environment where we are breaking new ground every day, this may be as good a starting place for further discussion as we can currently find. 





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