'Regime Uncertainty' And Its Impact On Economic Growth
Since the financial collapse of 2008, economic policymakers have struggled to revive the economy. In the United States, the centerpiece of the Obama administration's fiscal policy was a massive stimulus program that pumped $787 billion into the American economy. At the same time the Federal Reserve launched a series of quantitative easing programs in an attempt to prop up markets and spur economic growth. Yet five years after the collapse, the economy remains weak, with anemic growth rates of around 2 percent and unemployment hovering at 7.3 percent. This has left economists asking why, and many are suggesting that policy uncertainty is a key factor limiting the economic recovery. Given the brinksmanship between Congress and the president over whether the nation will default on its debt, it is easy to see how uncertainty over policies coming out of Washington can make businesses wary about undertaking new business ventures.
As others have noted, there was a marked divergence between corporate profits and investment after the 2008 meltdown, with corporate profits surging while investment dropped sharply. Many attribute this to increased trepidation over the general economic outlook and a "wait and see" attitude among corporate leaders with respect to new capital investments. The economic recovery has been halting at best, and weak consumer demand has left many waiting for clear signs the economy has turned the corner before committing resources to new projects.
Indeed, such caution may be warranted. In the wake of the president's stimulus package, policymakers faced a daunting fiscal cliff and, more recently, a government shutdown. Both episodes exemplify the inability of Washington to come to grips with mounting budgetary concerns. The debt ceiling fight and budget impasse bespeak a larger problem of structural deficits stemming from a fiscal imbalance between spending and revenues. The most recent standoff once again signals a lack of will to address this more fundamental problem, which injects a degree of uncertainty into economic thinking. Simply raising the debt ceiling does nothing to improve the government's ability to repay its debt. Moreover, ending the government shutdown with another short-term debt ceiling increase merely assures another "crisis" when the next debt ceiling approaches.
At the same time, markets are facing substantial changes with respect to regulatory policy. The Patient Protection and Affordable Care Act's restructuring of the health care sector is now underway, with significant impacts for both consumers and businesses. In addition, the financial sector is facing a host of new regulations as the Dodd-Frank reforms are being implemented. The Environmental Protection Agency has also launched a series of new regulations that may require significant restructuring in the energy sector. All of these are works in progress that may have many industries waiting for the regulations to unfold before considering any investment options.
With markets in flux and being restructured by policymakers, it is reasonable to suggest that uncertainty may have an impact on economic decisions. Yet some have tried to dismiss the notion of policy uncertainty as too nebulous to have any meaning. Economists Scott R. Baker, Nicholas Bloom and Stephen J. Davis have tried to address such concerns by creating an index of "economic policy uncertainty."
This index includes three components to develop a measure of uncertainty. The first tracks newspaper stories covering economic policy uncertainty. The second tracks Congressional Budget Office reports on federal tax code provisions that are expiring or being revised. The third component examines disagreements among economic forecasters. The authors find their index fits well with events that have economic consequences, such as the Lehman Brothers bankruptcy, the 9/11 attack and the 2011 debt ceiling debate, as can be seen in the chart below.
The work of Baker and his co-authors provides an important step for better understanding the impact that uncertainty can have on economic decision-makers, both in the market and in government. A market is simply a set of institutions that allows economic actors to transact with one another. Laws and regulations that come out of Washington alter the underlying institutions and, consequently, the incentives of those in the marketplace. Clearly it is important to examine the impacts of monetary and fiscal policy on economic output. But other forces are at work as well, and a better understanding of economic policy uncertainty may prove valuable for assessing the impact that Washington has on economic actors.