The fiscal cliff and the economy: Pointless, painful uncertainty
Jul 18th 2012, 20:59 by G.I. | WASHINGTON
Many academics count things that proxy for uncertainty, such as mentions of the word in news articles. That’s one of the components in the uncertainty index developed by Scott R. Baker, Nicholas Bloom, and Steven J. Davis whose work we wrote about it here; it links heightened policy uncertainty to weaker growth. It’s also used by Jonathan Brogaard and Andrew Detzel here; they find increased policy uncertainty leads to lower stock prices and private investment.
Establishing causality is tricky. A weak economy or a traumatic event like a financial crisis or terrorist attacks will both raise uncertainty and provoke a policy response, but it’s the economic event, not the policy, that raises uncertainty and hurts growth.
I have my own back-of-the-envelope exercise. I count mentions of the word “uncertainty” in the Federal Reserve’s “beige book.” As my nearby chart shows, uncertainty has shot up in the last month. (Some months are blank because no beige book was released then.)
The beige book is a narrative based on conversations between analysts at the Fed and business contacts throughout the country. While this means it’s not well suited to quantitative analysis such as mine, it does allow you to isolate the source of the uncertainty.
Usually, it’s the economic or sales outlook. Often, it’s an event beyond America’s control: the European crisis, higher petrol prices, Japan’s tsunami, and so on. Some months, though, the source is clearly exogenous policy decisions. In April of 2011, the federal budget was cited in three of that month’s 15 references to uncertainty. Recall that that month the government was on the verge of shutting down over Republican pressure for cuts to discretionary spending. One reference was to the future of Fannie Mae and Freddie Mac.
Uncertainty rose again in July; four of 14 references were related to fiscal policy, almost certainly because of the fight over whether to raise the debt ceiling (explicitly cited twice). The downgrade to America’s credit rating that following the debt ceiling negotiations and the intensification of Europe’s crisis sent stock markets tumbling, which explains the spike in uncertainty in September.
Uncertainty appears more often in this month’s beige book than any month since September. Five of 30 references cite fiscal policy, apparently a reference to the fiscal cliff. A sampling:
The Chicago District noted uncertainty over the effects of U.S. fiscal policy actions was reducing their customers’ demand for credit… The Boston, Cleveland, Atlanta, Chicago, and Dallas Districts said employment levels were flat to up slightly, with most contacts citing U.S. fiscal policy uncertainty or weak demand for their conservative approach to hiring… [M]any contacts had become more cautious about future spending decisions, pointing to the heightened uncertainty surrounding the federal fiscal environment and the upcoming November elections.
Conservatives and businesses often blame uncertainty about new regulations such as health care for the economy’s weakness. That argument doesn’t get much support from the beige books. This doesn’t mean they’re wrong. Many individual regulations may in aggregate produce significant uncertainty that doesn’t show up in this exercise. However, such background anxiety can’t really explain the periodic spikes in uncertainty and associated economic slowdowns. (Monetary policy, another frequently-cited source of uncertainty, is never mentioned as such in beige books I examined; on the other hand, consider the source.)
So this admittedly crude exercise seems to demonstrate that in terms of economic impact, fiscal policy trumps all other exogenous sources of policy uncertainty. Why does this matter? Because it’s so pointless. It’s not surprising or even necessarily bad that tighter fiscal policy leads to weaker growth. That may be the price of sustainable public finances. But the disincentives to hire and invest brought on by the debt ceiling battle and now the fiscal cliff aren’t the result of fiscal policy per se, but by the reckless and confrontational way that America makes it. Little wonder Ben Bernanke, the Fed chairman, spent so much of the last two days begging Congress to act on the cliff. Such action is not a substitute for more quantitative easing; but the stimulative impact would so much greater, with far fewer side effects.
The original post is linked here.