Does Uncertainty Breed Confidence?
Does economic uncertainty breed confidence?
The Economic Policy Uncertainty Index suggests that global economic uncertainty has reached unprecedented high levels in the last few months, far above the 2008–09 Global Financial Crisis and the 2011–12 Eurozone debt crisis.
This is partly driven by a surge of economic uncertainty for China:
But even for the US, economic uncertainty as measured by this index seems as high as it was during the Global Financial Crisis and subsequent recession.
The index is extremely volatile, but if we zoom in to the last ten years, the trend line is perfectly flat: looks like economic uncertainty abated briefly between 2013 and 2015 only to return to crisis levels.
Yet consumer confidence just reached a 15-year high, according to the Michigan index:
And business confidence hovers at record high levels, miles above the 2008–09 through, judging by the NFIB Small Business Optimism index.
The previous recent spike in US economic uncertainty occurred at the end of 2016, at the same time as consumer confidence rose and small business confidence surged.
So, does higher economic uncertainty boost consumer and business confidence? If that’s the case, it would have some tantalizing policy implications: erratic, capricious and unpredictable economic policies should boost economic growth.
Or maybe something here doesn’t add up.
Can economic uncertainty today really be higher than ten years ago? Back in 2009 we plunged in a deep global recession, the worst we have experienced in the US since the Great Depression. The financial system had been left paralyzed by an unprecedented financial crisis. Among policymakers, business leaders and economists there was a palpable widespread fear, a sense that we were not sure how we could get out of this crisis and how bad it would be.
Today by comparison we are on much firmer ground. Yes, there are question marks: how bad will trade tensions get, and how much of an impact will they have? Why are wages and prices not rising at a faster pace? Is there a risk of new financial bubbles with interest rates so low and liquidity so abundant? But these are manageable uncertainties, in a context where economic growth in the US and the world at large is very solid. Back in 2009 we faced a much more extreme, systemic economic uncertainty.
Maybe the devil is in the details of the index. The Economic policy Uncertainty Index, developed by a team of academics, looks at three things: (1) how much uncertainty is reflected in media reports; (2) the extent to which economists have different forecast of key economic variables; (3) tax legislation due to expire soon.
Let’s look at the components for the US index. Uncertainty due to expiring tax legislation looks lower:
Uncertainty reflected in economic forecasts, in the case of the US has two subcomponents, forecasts of government spending and inflation (CPI) forecasts. Both look lower than ten years ago.
Which means that what drives this uncertainty index is the media component — by far the most volatile, with impressive panic spikes. The news component accounts for a full half of the US index, according to the website. To me, this is a very dubious choice of weights. The media has become increasingly prone to hyperbole, because that’s what captures a bigger audience. And if you plot the difference between media uncertainty and overall uncertainty, starting around the time of the 2016 Presidential elections media uncertainty has been systematically higher than overall uncertainty, often by a substantial margin.
All this has an important implication for economic analysis and investment decisions:
Though economic uncertainty is a lot lower today than ten years ago, the perception of uncertainty created by click-hungry media keeps climbing higher and higher. And if we buy into the media’s measure of uncertainty, we will seriously misjudge business decisions and economic trends — especially as business leaders have a pragmatic ability to adapt to even genuine uncertainty such as Brexit and trade tensions.
