The damaging impact of economic uncertainty on growth has been reasonably well studied - but what happens when there is uncertainty about economic policy-making? Nicholas Bloom and colleagues have developed a measure of this distinct kind of uncertainty, one that shows the value of restoring stability to current policy actions.US economic policy, global financial markets,

Nicholas Bloom

Scott R. Baker

Steven J. Davis

English

Research Papers in Economics

T
he most striking thing about
the recent volatility of global
financial markets is that
politicians are making the
news. The actions of policy-makers and
their statements about budgets, bailouts
and regulatory reforms are driving the
stock market gyrations. 
This is not normal. Before the financial
crisis of 2008, stock markets usually
moved in response to economic news.
Strong GDP and employment figures
would send the markets soaring. Poor
corporate earnings would send the
markets crashing. 
But today, all eyes are on the policy-
makers. Unfortunately, they cannot agree,
which is generating massive uncertainty. In
fact, according to our new index, which
charts the evolution of US economic policy
uncertainty since 1985, it is now close to
its all-time high (see Figure 1). This policy
uncertainty is a key factor stalling the
recovery and threatening a return to
recession.
We construct our index of policy
uncertainty by combining three types of
information: the frequency of newspaper
CentrePiece Winter 2011/12 
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The damaging impact of economic uncertainty 
on growth has been reasonably well studied – but
what happens when there is uncertainty about
economic policy-making? Nicholas Bloom 
and colleagues have developed a measure of 
this distinct kind of uncertainty, one that shows
the value of restoring stability to current 
policy actions.
Policy uncertainty:
a new indicator
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Notes: The index is composed of three sets of measures: monthly news articles containing
‘uncertain’ or ‘uncertainty’,‘economic’ or ‘economy’, and policy-relevant terms (scaled by the
smoothed number of articles containing ‘today’); the number of tax laws expiring in coming
years; and a composite of quarterly forecasts of government expenditures and one-year 
CPI (consumer price index) from the Philadelphia Fed Survey of Forecasters.The data are
available at www.policyuncertainty.com.
Figure 1:
Index of US economic policy uncertainty
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)articles that reference economic
uncertainty and the role of policy; the
number of federal tax code provisions that
are set to expire in coming years; and the
extent of disagreement among economic
forecasters about future inflation and
future government spending on goods
and services.
Our index shows sharp spikes in
economic policy uncertainty around major
elections, wars and the 9/11 terrorist
attacks. More recently, it spiked sharply
after the Lehman bankruptcy in
September 2008 and the passage of the
TARP (Troubled Asset Relief Program)
legislation shortly afterwards. It has
remained high ever since, driven by
continuing policy uncertainty around the
2010 US mid-term elections, the US debt
ceiling dispute and the crisis of the
eurozone. 
Of course, policy uncertainty could be
high simply because general economic
uncertainty is also high. To test this view,
we use Google News listings to construct
a broad index of economic uncertainty
and a narrower index focused squarely on
policy uncertainty.
Comparing these two indices reveals
several episodes that involve large spikes
in economic uncertainty but little or no
jump in policy uncertainty (see Figure 2).
Examples include the Asian financial crisis
of 1997 and several bouts of recessionary
fears in the second half of the 1980s. 
In short, the data refute the view that
economic uncertainty necessarily breeds
policy uncertainty.
So why is policy uncertainty so high
now? To identify the drivers of policy
uncertainty, we drill into the Google 
Figure 2:
Economic policy uncertainty and overall
economic uncertainty
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2009 2011 2007 2005 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985
■ Policy-related news-measured economic uncertainty
■ Overall news-measured economic uncertainty
CentrePiece Winter 2011/12 
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Notes: The overall news-based economic uncertainty index is composed of the monthly 
number of news articles containing ‘uncertain’ or ‘uncertainty’ as well as ‘economic’ or ‘economy’
(scaled by the smoothed number containing ‘today’).
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Recent policy
uncertainty has
emerged from
the US debt
ceiling dispute
and the 
eurozone crisis
Policy
Uncertainty
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q
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r
yWhat makes policy uncertainty so
harmful? When businesses are uncertain
about taxes, healthcare costs and
regulatory initiatives, they adopt a
cautious stance. Because it is costly to
make a hiring or investment mistake,
many businesses naturally wait for calmer
times to expand. If too many businesses
wait to expand, the recovery never takes
off. Weak investments in capital goods,
product development and worker training
also undermine longer-run growth.
How much near-term improvement
could we expect from a stable, certainty-
enhancing policy regime? We use
techniques developed by Christopher
Sims, one of the two 2011 Nobel
laureates in economics, to estimate the
effects of economic policy uncertainty.
The results for the United States
suggest that restoring 2006 (pre-crisis)
News listings and quantify the mix of
factors at work. Several factors underlie
the high levels of US policy uncertainty in
2010 and 2011, but monetary and tax
issues predominate.
One clear example involves the 
Bush-era income tax cuts originally set to
expire at the end of 2010. Democrats and
Republicans adopted opposing positions
about whether to reverse these tax 
cuts. Rather than resolve the uncertainty
in advance, Congress waited till the 
final hour before deciding to extend the
tax cuts.
Other examples include recent moves
in the US Senate to increase tariffs on
Chinese imports, which threaten to set off
a trade war. And in Europe, the continuing
debates over potential bailouts for
countries and banks contribute to a
climate of policy uncertainty. 
This article summarises ‘Measuring 
Economic Policy Uncertainty’ by 
Scott R Baker, Nicholas Bloom and 
Steven J Davis (www.policyuncertainty.com).
Scott R Baker is at Stanford University.
Nicholas Bloom, also at Stanford University,
is a research associate in CEP’s productivity
and innovation programme. Steven J Davis
is at the University of Chicago’s Booth 
School of Business.
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24 26 28 30 32 34 38 22 20 18 16 14 12 10 8 6 4 2 0
■ Average estimate of change in production/employment in 
    response to increased policy uncertainty
■ One standard-error bands
0
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24 26 28 30 32 34 38 22 20 18 16 14 12 10 8 6 4 2 0
CentrePiece Winter 2011/12 
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Figure 3:
US production and employment after a policy
uncertainty shock
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Months elapsed since the policy uncertainty shock
Restoring 
pre-crisis levels
of policy
uncertainty could
boost production
and employment
significantly 
levels of policy uncertainty could increase
industrial production by 4% and
employment by 2.5 million jobs over 
18 months (see Figure 3). That would 
not be enough to create a booming
economy, but it would be a big step in 
the right direction.

Policy uncertainty: a new indicator

http://cep.lse.ac.uk/pubs/download/cp362.pdf

Policy uncertainty: a new indicator

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