Headlines 2015

Policy uncertainty curbs economic growth


From left Ulf Kristersson, Steven Davis, John Hassler and Max Elger. Photo: Bosse Johansson.

Does policy uncertainty curb economic growth? Yes, said Professor Steven Davis, University of Chicago Booth School of Business, at a seminar organized by IFN in Stockholm on December 16. A Swedish example of uncertainty created by the politicians is the government's announcement that distribution of profits in the service sector will be restricted. Steven Davis pointed to the refugee flows that create uncertainty in European societies. Davis is co-founder of the Economic Policy Uncertainty Index, which measures economic uncertainty and its impact on production, investment and employment. A panel discussed Davis’ finding: Max Elger, State Secretary in the Ministry of Finance, Ulf Kristersson, Economic Policy Spokesperson for the Moderate Party and Professor John Hassler, Chairman of the Swedish Fiscal Policy Council.

Steven Davis is a founder of the Economic Policy Uncertainty Index. Photo: Bosse Johansson.

Steven Davis explained that today's extensive wave of refugees into Europe creates uncertainty that affects growth. The same goes for numerous political decisions. And, as Steven Davis said, decisions must not be about the economy as such but still has repercussions in terms of the economy, for example security policy.

“In this diagram (see below), we see different occurrences in the United States between 1985 and 2015. These episodes created uncertainty about what decisions the politicians would take as a result of the “shocks”. These are shocks are not part of a normal political or political decision making process, such as acts of terrorism,” explained Steven Davis

Steven Davis has also developed an index of what happens when countries take in refugees. Two further criteria for selection of media clips have been added to the original EPU index - fear and migration – measuring fears linked to the influx of refugees. The researchers have so far done this for France, USA, Germany and Great Britain.

“Both fear and migration has accelerated in recent years,” explained Davis at the seminar when showing a chart from the UK.

He continued with a chart from Germany where fear has grown dramatically in the last quarter of 2015 (measured until November 30).

“The fear or concern over immigration has increased tenfold in recent months compared to the entire period [1995-2015],” said Steven Davis. He explained that this was not unexpected since the shock (read stream of refugees) forces policy makers to discuss and decide on what needs to be done, making controversial decisions which create political uncertainty.

Davis explained that these and other "shocks" that entails increased political uncertainty foreshadows a decline in terms of investment, employment and output.


Steven Davis graf.png
Steven Davis presenting fact from a study by Scott R. Baker, Nicholas Bloom and Steven J. Davis: "Measuring Economic Policy Uncertainty".

“The EPU Index is based on computerized
search results from newspapers,” explained Steven Davis.

Computers are searching for certain words such as economic, regulation and uncertainty. In addition, students make an audit study following a detailed handbook, going through and encoding the newspaper material.

Today, the EPU Index I used by a number of companies for analysis and forecasting, including big banks like Citibank and Wells Fargo and media companies such as Reuters and Bloomberg.


Steven Davis has also studied how fear is growing in the wake of the large flow of refugees into Europe. Photo: Bosse Johansson.


Steven Davis concluded:

1. Policy uncertainty fluctuates in response to major economic shocks; policy disputes, elections and other political factors; and other shocks (e.g., war and terrorist attacks). A mix of domestic and foreign disturbances.

2. The institutional setting and policy making environment strongly influences whether unforeseen shocks and developments trigger high levels of policy uncertainty.

3. Econometric evidence indicates that:

• Positive EPU innovations foreshadow lower investment, output and employment at the national level.

• EPU raises firm level stock price volatility and reduces hiring & investment in sectors with high exposure to policy

4. Textual analysis of newspapers offers a powerful means of creating new economic data and testing hypotheses.

Hemsidan3.jpgProfessor John Hassler, chairman of the Swedish Fiscal Policy Council, explained that some political uncertainty is an inevitable part of a democratic society. Photo: Bosse Johansson.

Max Elger, State Secretary of Finance Minister Magdalena Andersson, pointed out that media's "voice" has changed over the years, as a result of technological developments and hence given us more channels. Perhaps it is therefore not accurate to use the media articles for an index. He continued:

“We are concerned about the uncertainty, but uncertainty is fine as long as the policy is sustainable in the long run.

Ulf Kristersson explained that economics and politics often have different objectives. He also said that political uncertainty must not be negative. Though, he cautioned, we politicians should be aware that decisions made, and also the decisions that are not made, have major consequences for individuals.

Kristersson said that the migration crisis creates a lot of uncertainty, and that changes are needed in labor and housing markets. Also the discussions about the future of the welfare state create uncertainty. He stated that politicians can choose between pragmatism and long-term changes (which he prefers) or "the Swedish way", i.e. a U-turn forced by a crisis.

John Hassler said that the indexes Davis has developed are important contributions to our understanding of economic developments. We know that when the political uncertainty increases the willingness to invest decreases. But we do not know if this is temporary or permanent.

“I am convinced that the least possible uncertainty is good [for the economy], but we don’t know much more. And probably the best fiscal policy would be so boring that no journalists would write about it!

Also Hassler felt that uncertainty is something positive and an intrinsic part of democracy. He told a story of Dictator Muammar Gaddafi in Libya who, speaking to a journalist, said that he despised western democracies because 51 percent of the population can decide over 49 percent. And this is, according to Gaddafi immoral and creates a lot of uncertainty. So how are you doing in Libya, the journalist wondered. "We all agree," replied Gaddifi.


Panorama 1.jpg
The seminar drew a large audience comprised of academics, officials, politicians, organizations and the media. Photo: Bosse Johansson.


Steven Davis presentation

The seminar on Twitter #ifnentrepreneurship

An interview with Steven Davis by the Swedish Radio (Ekonomi Ekot) will be broadcasted January 9, 2016.

Research Institute of Industrial Economics, Grevgatan 34 - 2 fl, Box 55665, SE-102 15 Stockholm, Sweden | Phone: +46-(0)8-665 45 00 | info@ifn.se