by Don Alexander, MBA
RSD Solutions Inc.
A striking feature of recent equity market volatility is that politicians and government bureaucrats are making the news. It seems that statements about bailouts, restructuring, budgets and regulatory reforms are driving stock market volatility. Policymakers’ and bureaucrats choices are dominating headlines in the global crisis.
Policy uncertainty and the stalled recovery (Scott Baker, Nicholas Bloom & Steve Davis, VOXEU, October 22nd). The authors distinguish between economic uncertainty and economic policy uncertainty, constructing an index to measure policy-related uncertainty and argue that reducing policy uncertainty would add dramatically to job creation. Prior to the financial crisis of 2008, stock markets moved in response to economic numbers such as GDP or employment and corporate earnings. But today, it is politicians and government bureaucrats. They cannot agree, generating massive economic uncertainty. This policy uncertainty is a key factor in stalling the recovery and contributing to the risk of a double dip.
Baker et al constructed a new index of US policy uncertainty by combining three types of information: frequency of articles that reference economic uncertainty and policy, references to expiration of various federal tax code provisions and disparity among forecasts about inflation and government purchases of goods and services. In addition, the authors are able to separate an indicator of economic uncertainty from that of policy uncertainty. They note the key drivers of policy uncertainty are dominated by monetary and tax issues.
When businesses and investors are uncertain about taxes, health care costs, budget prospects and regulatory initiatives, they adopt a cautious stance. They find it costly to make a hiring or investment mistake, waiting for calmer times to expand or consider riskier investments. As a result, the recovery never takes off as business remains cautious on making investments in capital goods, research and worker training – key determinants for long-run sustainable growth.
Investors remain on the sidelines in “safe” investments avoiding risk.
The lessons for European and US policymakers are clear. They need to take action that will reduce policy uncertainty for business and investors.
For more on this follow the link: www.voxeu.org/index.php?q=node/7137
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