Myron  Scholes  Global  Market  Forum        

 

What’s  Holding  Back    the  U.S.  Economy?  

   

Remarks  by  Steven  J.  Davis  faculty.chicagobooth.edu/steven.davis/  

William  H.  Abbo@  Professor  of  InternaDonal  Business  and  Economics  

 

9  November  2011    

Outline  of  Remarks  •  New  Measure  of  Economic  Policy  Uncertainty  

– News-­‐based  index  (1/2  weight)  –  Forecaster  disagreement  about  inflaDon  (1/6)  –  Forecaster  disagreement  about  govt.  purchases  (1/6)  –  Scheduled  tax  code  expiraDons  (1/6)  

•  EvaluaDng  the  Measure  •  Dynamic  RelaDonship  to  Output,  Employment  and  Investment  

•  How  Does  Policy  Uncertainty  Hold  Back  the  Economy?  

Polic

y U

ncer

tain

ty In

dex

1st Gulf War

9/11

Clinton Election

2nd Gulf War

Bush Election

Balanced Budget Act

Lehman and

TARP

Index of U.S. Economic Policy Uncertainty, January 1985 to August 2011

Eurozone Crisis, 2010

Midterms

Stimulus Debate

Obama Election, Banking

Crisis

Debt Ceiling Dispute

Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis, October 2011, at http://faculty.chicagobooth.edu/steven.davis/pdf/PolicyUncertainty.pdf.

Figure 3: Tax Code Expiration Index

Notes: Utilizes List of Tax Code Expirations from the Joint Congressional Committee on Taxation. Each year, the JCT provides a list of expiring tax laws in the current and next 10 years. We weight expirations T months in the future by 0.5^((T+1)/12) and update the index value each January.

Tax

Legi

slat

ion

Expi

ratio

n In

dex

Indexes of Scheduled Tax Code Expirations Based on CBO Data, Preliminary

Figure 2: News-Based Policy Uncertainty Index Po

licy

Unc

erta

inty

New

s In

dex

1st Gulf War

9/11

Clinton Election

2nd Gulf War

Bush Election

Stimulus Debate

Lehman and

TARP Euro Crisis, 2010

Midterm

Notes: News-Based Policy Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty, economic or economy, as well as policy relevant terms (scaled by the smoothed number of articles containing ‘today’). Policy relevant terms include: ‘policy’, ‘tax’, ‘spending’, ‘regulation’, ‘federal reserve’, ‘budget’, and ‘deficit’. Series is normalized to mean 100. Index covers Jan 1985-Aug 2011. Query Run August 11, 2011 and updated Sept 25, 2011.

Tax Cuts

Russian Crisis/LTCM

Debt Ceiling Dispute

Obama Election, Banking

Crisis

Figure 12: News-Based Financial Uncertainty Index Fi

nanc

ial U

ncer

tain

ty In

dex

Notes: News-Based Financial Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty, economic or economy, as well as terms relevant to financial markets (normalized by the number of articles containing ‘today’). These terms include economic or economy as well as ‘stock prices’, ‘equity prices’, or ‘stock market’. VIX is scaled so both series have equal means. Google query run June 15, 2011. Data January 1985-May 2011.

1st Gulf War

9/11

Lehman Bankruptcy

2nd Gulf War Asian Crisis

Russian Crisis/LTCM Black Monday

Figure 7: Relationship of News-Based Index of Overall Economic Uncertainty to News-Based Index of Policy-Related Economic Uncertainty

45

67

log(

Econ

omic

Unce

rtain

ty)

3.5 4 4.5 5 5.5 6log(Policy Uncertainty)

1985-1989 1990 to August 2001September 2001 Onwards

R-Squared: 0.68 Slope: 0.79 (0.05)

R-Squared: 0.88 Slope: 0.98 (0.03)

R-Squared: 0.53 Slope: 1.50 (0.19)

Table  1:  Intensity  and  ComposiDon  of  Policy-­‐Related  Economic  Uncertainty  by  Period  

Figure 8: Estimated Dynamic Effect of a Policy Uncertainty Shock In

dust

rial P

rodu

ctio

n Im

pact

(%

dev

iatio

n)

Months after the economics policy uncertainty shock

Notes: This shows the impulse response function for Industrial Production and employment to an 124 unit increase in the policy-related uncertainty index, the increase from 2006 (the year before the current crisis) until the first 8 months of 2011. The central (black) solid line is the mean estimate while the dashed (red) outer lines are the one-standard-error bands. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log industrial production and time trend. Data from 1985 to 2011.

Empl

oym

ent I

mpa

ct

(mill

ions

)

-5-4

-3-2

-10

12

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36

-3-2

-10

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36

How  Does  Policy  Uncertainty    Hold  Back  the  Economy?  

Five  Channels  1.  More  precauDonary  savings,  more  deleveraging  2.  When  investment  and  hiring  decisions  are  costly  

to  reverse,  greater  uncertainty  depresses  and  delays  investment  and  hiring  

3.  More  costly  debt  finance    4.  Managerial  risk  aversion    5.  IntensificaDon  of  agency  problems,  reducing  the  

value  of  new  and  exisDng  employment,  business  and  financial  relaDonships  

More  on  Economic  Policy  Uncertainty  •  “Uncertainty  and  the  Slow  Recovery,”  Gary  S.  Becker,  Steven  J.  Davis  and  Kevin  M.  Murphy,  Wall  Street  Journal,  3  January  2010.  

•  “Policy  Uncertainty  Is  Choking  Recovery,”  Sco@  R.  Baker,  Nicholas  Bloom  and  Steven  J.  Davis,  Bloomberg  View,  5  October  2011  

•  Policy  Uncertainty  and  the  Stalled  Recovery,”  Sco@  R.  Baker,  Nicholas  Bloom  and  Steven  J.  Davis,  VOX,  22  October  2011.  

•  “Measuring  Economic  Policy  Uncertainty,”  Sco@  R.  Baker,  Nicholas  Bloom  and  Steven  J.  Davis,  working  paper,  10  October  2011  

AddiDonal  Slides  –  Not  for  Prepared  Remarks  

Figure 4: Federal Government Purchases, Index of Interquartile Range of One-Year Ahead Forecasts

Fede

ral E

xpen

ditu

res

For

ecas

ters

IQ R

ange

Inde

x

Notes: From the Philadelphia Federal Reserve Survey of Professional Forecasters. Takes the interquartile (IQ) range of the 1-year ahead forecasts (which are made every quarter) of total federal government expenditures relative to the mean forecast. Normalized to a mean 100 index.

Balanced Budget Act

Clinton Election

9/11

Budget Battle

Obama Election,

Banking Crisis

Figure 5: One-Year Ahead CPI Forecasts Interquartile Range Index

Notes: From the Philadelphia Federal Reserve Survey of Professional Forecasters. Takes the interquartile (IQ) range of the 1-year forecasts of CPI (which are made every quarter). Normalized to a mean 100 index.

CPI

For

ecas

ters

IQ R

ange

Inde

x

2nd Gulf War/ Fed Drops Interest Rates

1st Gulf War

Clinton Election

Obama Election, Banking

Crisis

Balanced Budget Act

Budget Battle

Figure 10: Quarterly VAR estimates for GDP and investment

Months after the policy uncertainty shock

GD

P Im

pact

(%

dev

iatio

n)

-4-3

-2-1

0

0 2 4 6 8 10 12

Inve

stm

ent I

mpa

ct

(% d

evia

tion)

Notes: Shows the impulse response function to an 124 unit increase in the policy-related uncertainty index, the increase from 2006 (the year before the current crisis) until the first 8 months of 2011. The central (black) solid line is the mean estimate while the dashed (red) outer lines are the one-standard-error bands. E s t i m a t e d u s i n g a quarterly Cholesky VAR: the uncertainty index, log(S&P 500 index), federal reserve funds rate, log e m p l o y m e n t , l o g i n v e s t m e n t , l o g consumption and log GDP. Data from 1985 to 2011.

-20-15

-10-5

05

0 2 4 6 8 10 12

Figure 9: Robustness of Estimates to Different VAR Specifications

Months after the policy uncertainty shock Notes: This shows the impulse response function for GDP and employment to an 124 unit increase in the policy-related uncertainty index. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log industrial production and time trend unless otherwise specified. Data from 1985 to 2011.

Indu

stria

l Pro

duct

ion

Impa

ct

(% d

evia

tion)

Baseline Reverse order

Bivariate (uncertainty and log industrial production)

-5-4

-3-2

-10

Est

imat

ed im

pact

on

indu

stria

l pro

duct

ion

0 5 10 15 20 25 30 35

Three months of lags

Nine months of lags

Uncertainty index has equal weight on measures

Adding VIX first as a control for economic uncertainty