Policy uncertainty and the economy: A new index to gauge the pain

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Event Summary

The world is facing a prolonged period of tepid economic growth compounded by uncertainty about what policies will govern the economy in coming years. Economists have long argued that economic policy uncertainty is often detrimental to growth, and AEI's Steve Davis presented a new way to quantify and better understand that uncertainty at an event on Friday. Davis showed how the meteoric elevation of uncertainty — driven by a nebulous tax code, political polarization, and indecision about entitlement reform — is crippling the economy's ability to recover from the 2008 financial crisis.

Greg Ip of the Economist pointed out that not all policy uncertainty is bad, but politicians need to do a better job of building consensus about policy and setting clear parameters for future regulation. John Makin of AEI then explained how monetary policy uncertainty engendered by the Fed in recent months has increased precautionary cash holdings by companies fearful of policy shocks. As the panel concluded, politicians must reduce uncertainty and get businesses to deploy their cash holdings if economic growth is to resume robustly.
--Daniel Hanson

Event Description

As the U.S. fiscal cliff looms, government debt mounts and the euro remains embattled, the topic of policy uncertainty is attracting more attention. Some economists suggest that high levels of uncertainty partly explain the sluggish economic recovery following the financial crisis and Great Recession of 2009.

In an attempt to quantify policy uncertainty and its role in economic performance, Steven Davis of AEI and two Stanford economists, Scott Baker and Nicholas Bloom, have developed a new index that draws on media coverage of uncertainty, expirations of temporary tax provisions and disagreement among professional forecasters about the future outlook of inflation and government spending. Their index offers a new tool for assessing the level of uncertainty and its effects on household and business spending, investing and hiring.

At this event, Davis will present his research on the topic and a panel of experts will discuss.

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About the Author

 

Kevin A.
Hassett

 

John H.
Makin

 

Steven J.
Davis
  • Steven J. Davis studies unemployment, job displacement, business dynamics, the effect of taxes on work activity, and other topics in economics. He is deputy dean for the faculty and professor of international business and economics at the University of Chicago Booth School of Business, a research associate at the National Bureau of Economic Research, and an economic adviser to the U.S. Congressional Budget Office.  He previously taught at Brown University and MIT.  As a visiting scholar at AEI, Mr. Davis studies how policy-related sources of uncertainty affect national economic performance.

 

Stan
Veuger

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