Does Policy Uncertainty Matter?

Transcription

1 Does Policy Uncertainty Matter? Nicholas Bloom (Stanford University) based on research with Scott Baker (Kellogg) & Steve Davis (Chicago) help from Abigail Haddow (Bank of England) and Jagjit Chadha (Kent) MMF Conference, September 25 th 2015

2 Uncertainty has been in the media a lot

3 But for some people the best evidence that uncertainty is important that.

4 .Paul Krugman thinks it is not important

5 Three Questions on Policy Uncertainty 1) Theory: why might policy uncertainty matter for growth? 2) Data: can we measure policy uncertainty? 3) Empirics: has policy uncertainty lowered growth since 2008?

6 Three key theory channels for uncertainty 1) Cost of capital: Tobin (1958) shows how risk raises borrowing cost for firms and consumer, cutting investment and spending 2) Real options: Arrow (1959), Bernanke (1983), and Dixit & Pindyck (1994) highlight how uncertainty cuts demand by making firms & consumers cautious when mistakes are costly 3) Financial constraints: Recent papers like Gilchrist, Sim and Zakrajsek (2010) focus on how uncertainty can exacerbate financial constraints (e.g. firms hoard dead cash ) Further reading: Fluctuations in uncertainty, by Nicholas Bloom, Journal of Economic Perspectives,

7 Three Questions from Theory to Empirics 1) Theory: why might policy uncertainty matter for growth? 2) Data: how can we measure economic policy uncertainty 3) Empirics: has policy uncertainty lowered growth since 2008?

8 Uncertainty including policy uncertainty - is hard to measure because it is not directly observed Unfortunately, no uncertainty barometer exits Uncertainty barometer

9 One measure is the Economic Policy Uncertainty (EPU) index from computer searches of newspapers For US use 10 major papers get monthly count of articles with: E {economic or economy}, and P {regulation or deficit or federal reserve or congress or legislation or white house}, and U {uncertain or uncertainty} Divide the count for each month by the count of all articles Normalize and sum 10 papers to get the U.S monthly index

10 Policy Uncertainty Index US News-based economic policy uncertainty index Fiscal Cliff Shutdown China slowdown Black Monday Gulf War I Clinton Election Bush Election Russian Crisis/LTCM 9/11 Gulf War II Stimulus Debate Lehman and TARP Debt Ceiling Debate Euro Crisis, and Midterm Elections Source: Measuring Economic Policy Uncertainty by Scott R. Baker, Nicholas Bloom and Steven J. Davis, all data at Data normalized to 100 prior to 2010.

11 Categorical Policy Uncertainty Indexes Can focus on narrower areas or economic policy uncertainty, e.g. : Defence and Healthcare Health Uncertainty Defence Uncertainty Gulf War I Clinton healthcare initiative Gulf War II Year Source: Measuring Economic Policy Uncertainty by Scott R. Baker, Nicholas Bloom and Steven J. 11 Davis, all data at Data normalized to 100 prior to /11 Affordable care act

12 Which policy areas account for high US policy uncertainty in ? Articles point to fiscal and healthcare policies (not monetary policy) Source: Measuring Economic Policy Uncertainty by Scott R. Baker, Nicholas Bloom and Steven J. Davis, all data at Data normalized to 100 prior to 2010.

13 UK Economic Policy Uncertainty is built in a similar way For UK use 2 major papers get monthly count of articles with: E {economic or economy}, and P {spending or policy or deficit or budget or tax or regulation or Bank of England}, and U {uncertain or uncertainty} Divide the count for each month by the count of all articles Normalize and sum 2 papers to get the U.K. monthly index

14 UK Policy Uncertainty Index note 6/9 of the uncertainty events are international Euro Crisis Russian Crisis/LTCM 9/11 Treaty of Accession/ Gulf War II Lehman Bros. Global Financial Crisis & Northern Rock General Election Scottish Independence Referendum General election Source: Data from 2 UK newspapers (Times and Financial Times)

15 Policy Uncertainty Index Immigration Act of Gulf War II Fiscal Cliff We can run the US index back to 1900 with 6 papers Gold T Standard Act McKinley Assassination Start of WW I Great Depression, New Deal and FDR Versailles Conf. Great Depression Relapse Truman- Dewey election Wage & Price Controls Gulf War I Black Monday OPEC I OPEC II Tet Debt Lehman Ceiling and TARP 9/11 Asian Financial Crisis Source: Measuring Economic Policy Uncertainty by Scott R. Baker, Nicholas Bloom and Steven J. Davis, all data at Data normalized to 100 prior to 2010.

16 Policy Uncertainty Index We can also run the UK index back to August 1914, WWI Begins Paris Peace Conference Germany Invades Poland, Britain Declares War Great Slump Germany Invades Norway & Denmark Feb-May 1946: Bank of England Nationalized; UK- Soviet Tensions; Parliament Votes to Nationalize Coal France Vetoes UK Entry to European Common Market Korean War Oil Shock, Miners Strike, Recession Gulf War I Currency Crisis Notes: The series is normalized to mean 100 from 1900 to 2008 and based on The Times of London and The Guardian. Gulf War II

17 UK government share of GDP is roughly flat since the 1950s (unlike the US where this has roughly doubled) Source: OBR

18 Policy Uncertainty Index Source: Based on 10 papers (El Pais, El Mundo, Corriere della Sera, La Repubblica, Le Monde, Le Figaro, the Financial Times, Times, Handelsblatt, FAZ.) European Economic Policy Uncertainty Index Russian Crisis/LTCM 9/11 Nice Treaty Referendum Treaty of Accession/ Gulf War II Italy Rating Cut Greek Bailout Request, Rating Cuts Lehman Bros. Northern Rock & Ensuing Financial Turmoil French and Dutch Voters Reject European Constitution Papandreou calls for referendum, then resigns Eurozone Stresses Greek crisis

19 India Based Policy Uncertainty Index Source: Data from 7 Indian newspapers (Economic Times, Times of India, Hindustan Times, Hindu, Statesman, Indian Express, and Financial Express) India Economic Policy Uncertainty Index Congress Party wins National Election Iraq Invasion Congress-Led Coalition Survives Confidence Vote Bear Stearns Lehman Failure Euro crisis and US debt ceiling debate Price Hikes Exchange Rate Fluctuations Rupee Collapse and Exchange Rate Concerns

20 China Based Policy Uncertainty Index Source: Data until August Based on newspaper articles from the South China Morning Post (Hong Kong) China Economic Policy Uncertainty Index /11 China Deflation and Deficit Eurozone Fears and Protectionism Inflation and Export Pressure Rising Interest Rates China Stimulus Stock Crash Political Transition and new National Congress Growth Slowdown Concerns

21 Policy Uncertainty Index North Korean Economic Policy Uncertainty Index Source: Data from 0 North Korean newspapers

22 But can we rely on newspapers search data? 22

23 A) Evaluation of Policy Uncertainty Index: Market Use Market use suggests information in our policy uncertainty data I) Numerous users including: Goldman Sachs, Citibank, JP Morgan, Blackrock, Wells Fargo, IMF, Fed, BoE, ECB etc II) This has led Bloomberg, FRED, Reuters and Haver to stream our data for their financial and policy users

24 Economic Policy Uncertainty Index (Blue) B) Comparison to stock volatility (the VIX for the US) Fiscal Cliff Shutdown Implied volatility on the S&P500 index (red) Correlation 1-month VIX and EPU index = 0.55 Correlation 10-year VIX synthetic and EPU index = 0.73 Gulf War I Clinton election Asian crisis LTCM default 9/11 WorldCom & Enron Gulf War II Large interest rate cuts Credit Crunch Obama Election, Banking Crisis Debt Ceiling Source: for the EPU and CBOE for the VIX

25 Economic Policy Uncertainty Index (Blue) B) Comparison to stock volatility (the IVI for the UK) Implied volatility on the FTSE All Share index (red) Euro Crisis Lehman Bros. Russian Crisis/LTCM 9/11 Treaty of Accession/ Gulf War II Northern Rock & Global Financial Crisis General Election Scottish Referendum Source: for the EPU and FTSE for the IVI. Data plotted quarterly.

26 C) Evaluation: Running Detailed Human Audits 10 undergraduates read 12,000 US newspaper articles using a 63-page audit guide to code articles if they discuss economic policy uncertainty 26

27 Policy Uncertainty Index Find humans and computers give similar results in large samples (in fact both make mistakes) Computer Human Source:

28 Three Questions from Theory to Empirics 1) Theory: why might policy uncertainty matter for growth? 2) Data: how can we measure economic policy uncertainty 3) Empirics: has policy uncertainty lowered growth since 2008?

29 Evaluate the impact of policy uncertainty in 3 ways 1. Surveys 2. Firm-level analysis (firm panel regressions) 3. Macroeconomic analysis (VAR estimations)

30 Surveys: WEF global CEO survey suggests uncertainty has been a major drag

31 US Survey evidence looks similar: claims uncertainty has been a drag December 2012

32 UK Survey evidence also looks similar:

33 2) Firm-level analysis: Use econometric analysis to see how firms respond to policy uncertainty Firm fixed effects Period fixed effects Y it = F i + P t + α*exp j *Gov t + β*exp j *EPU t + ε i,t Firm stock price volatility, or investment or hiring Firm government exposure government expenditure (1 st moment effect) Firm government exposure policy uncertainty (2 nd moment effect) i=firm, j=industry, t=quarter Estimated firm by quarter , standard-errors clustered by j

34 Find: (A) firms with greater government exposure - e.g. construction, defence and healthcare - have higher stock volatility when policy uncertainty rises Source: Baker, Bloom and Davis (2014), Measuring policy uncertainty

35 Find: (B) firms with greater government exposure have about 25% lower investment and hiring when policy uncertainty rises uncertainty cuts growth Source: Baker, Bloom and Davis (2014), Measuring policy uncertainty

36 3) Macro estimates: US data predicts the rise in policy uncertainty seen from 2006 to is followed by a drop in output of about 1.25% Industrial Production, (%) Employment Impact, (%) year year Months after the economics policy uncertainty shock

37 Unemployment Impact, (%) Industrial Production, (%) ) Macro estimates: UK data predicts the rise in policy uncertainty seen from 2006 to is followed by a drop in output of about 2% year year Months after the economics policy uncertainty shock

38 UK results are similar even after controlling for US EPU in the VAR (we see a 1.5% drop) Industrial Production, (%) Unemployment Impact, (%) year year Months after the economics policy uncertainty shock

39 Three Questions from Theory to Empirics 1) Theory: why might policy uncertainty matter for growth? 2) Data: how can we measure economic policy uncertainty 3) Empirics: has policy uncertainty lowered growth since 2008?

40 Finally has (policy) uncertainty been a factor behind very low UK and US investment rates?

41 Economic Policy Uncertainty Index (Blue) Bank of England Uncertainty Index Uncertainty policy and overall has been high in the UK but looks to be falling (for now at least) Source: for the EPU and Haddow, Hare, Hooley and Shakir (2013) for the Bank of England index

42 15 Investment as % of GDP And investment is bouncing back from the drop, but looks like it is on a longer downward trend US UK Year Source: World Bank Investment database, Gross Capital Formation % GDP

43 Conclusions 1. Economic theory has long emphasized the damaging effects of uncertainty on investment, hiring and consumer spending 2. Policy uncertainty is an important and controllable element of uncertainty, and appears to have risen during We estimate rising policy uncertainty may have cut UK output by about 2%, particularly in construction, defence & health 4. More speculatively, rising UK policy uncertainty comes from fiscal & political uncertainty (rather than monetary policy)

44 Policy Implications Three Strands 1. Monetary (Fiscal) Policy: should be predictable, transparent and stabilizing to (continue to) reduce policy uncertainty 2. Financial Stability: supporting the financial system in helped avoid a Great Depression sized surge in uncertainty 3. Impact of policy is lowered by uncertainty so a larger monetary and fiscal stimulus is needed for a given response

45 Broader literature review is available here

46 Finally, note all the data and research is online Data available at:

47 Does Policy Uncertainty Matter? Nicholas Bloom (Stanford University) based on research with Scott Baker (Kellogg) & Steve Davis (Chicago) Thanks to Abigail Haddow (Bank of England) and Jagjit Chadha (Kent) MMF Conference, September 25 th 2015

48 Back-Up

49 We also examine our 12 country panel and find similar 1% to 1.5% drops in output following the increases in policy uncertainty Industrial Production Impact (% deviation) Six months of lags Reverse bivariate (industrial production & EPU) Adding stock volatility Baseline (+ symbol) No country or time FEs Dropping stock-price Bivariate (EPU and industrial production) Months after the policy uncertainty shock

50 US Bias test: compare 5 most Republican and 5 most Democrat papers they looks similar 0 Reagan, Bush I Clinton Bush II Obama Papers sorted into 5 most Republican or Democratic groups using the media slant measure from Gentzkow & Shapiro (2010).

51 N-Grams (uncertain or uncertainty) jointly flat

52 N-Grams (economic or economy): jointly flat >1940

53 N-Grams: policy terms

54 Policy uncertainty earlier in time

55 True Positive 1 Code as EPU = 1, because the article discusses uncertainty surrounding the federal budget and particular factors related to agricultural subsidies and future legislation 55

56 False Positive 1 Computer mistake Should be EPU = 0, because the article does not mention uncertainty about policy, but the computer would code EPU=1. 56

57 False Negative 1 Computer mistake Should be EPU = 1 because the article mentions uncertainty over the exchange rate policy among central banks (computer codes as EPU = 0, because it never mentions any of the terms in the policy part of our search filter) 57

58 US VAR Robustness to Different Specifications Industrial Production Impact (% deviation) Reverse bivariate (industrial production & EPU) Pre-1985 data Baseline (+ symbols) No S&P index Six months of lags Adding a time trend Adding EU Adding VIX Bivariate (EPU and industrial production) Months after the policy uncertainty shock Notes: This shows the impulse response function for GDP and employment to an increase in the policy-related uncertainty index from the average to the average. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(s&p 500 index), federal reserve funds rate, log employment and log industrial production with 3 lags unless otherwise specified. Data from 1985 to 2012, except for the pre-1985 data spec which uses EPU and IP data from 1920 to 1984.

59 US Government expenditure is trending upwards Source: Bureau of Economic Analysis of federal, state and local government expenditure