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Is policy uncertainty holding back the economic recovery? Stanford economics professor John Taylor says it is and writes that "recent research by Ellen McGrattan and Ed Prescott (on increased regulations) and by Scott Baker, Nick Bloom, and Steve Davis (on policy uncertainty) supports this view." The U.S. Chamber of Commerce also advises via its recent small business survey that "concerns about over-regulation are the highest we’ve seen in the past year, with 42% of small businesses citing it as a major concern and 52% citing regulations as the top threat to their business."

Other lines of research find a connection between corporate investment and political uncertainty. For instance, a study in a recent issue of the Journal of Finance finds that "during election years, firms reduce investment expenditures by an average of 4.8% relative to nonelection years." Meanwhile, higher uncertainty about government policy is expected to have a negative impact on stock prices, according to a model in forthcoming paper in the Journal of Finance. And a recent NBER paper warns that political procrastination in resolving the long-term fiscal challenge for the U.S. "perpetuates uncertainty," which can be thought of as an "excess burden of government indecision."

The future, of course, is always uncertain. Deciding if there's an unusually high level of ambiguity harassing decisions in the here and now is tricky. In an effort to bring some clarity to the topic, three economics professors—Baker, Bloom and Davis (BBD), as noted above—have created an index of economic policy uncertainty in a recent paper and they update the benchmark monthly at PolicyUncertainty.com. The index reflects three data sets:

1. Monthly news stories that cite various references to uncertainty
2. A measure of tax code uncertainty based on tax code provisions set to expire each year
3. Macro uncertainty as defined by the dispersion of individual forecasts for several economic indicators via the database of Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters

BBD's policy uncertainty index has soared in recent years, giving ammunition to analysts who argue that an excess of doubt about the future is weighing on the economy. (For a good overview of the debate about the pace of the post-recession recovery, see John Cochrane's post here.) The question is whether BBD's definition of uncertainty truly captures the lion's share of this factor. For now, let's accept their index as a representative benchmark. By that standard, it's interesting to note that this policy uncertainty benchmark has dropped sharply in recent months and is now at the lowest level since just before the financial crisis exploded in the autumn of 2008. Should we now conclude that uncertainty is no longer a problem? If so, is the economy poised for stronger growth? Does anyone think that the drop in BBD's index will translate into more support for Obama's re-election prospects?

Clear answers are in short supply when you consider that rate of growth in private-sector payrolls, industrial production and other economic indicators have already rebounded to pre-recession levels in recent history despite the formerly elevated levels in BBD's policy uncertainty index. Is this a signal that an even stronger phase of growth awaits in the wake of BBD's fallen benchmark? Or is there a disconnect between this index and the real economy?

It seems that BBD's index raises more questions than it answers. The drop in BBD's index isn't likely to change anyone's mind, at least not until after November 6. Political uncertainty and economic uncertainty are connected, of course. The upcoming election will wipe away part of the doubt, although it's unclear if post-election clarity will clear up the rest of the misgivings.

The lesson in all of this? Uncertainty is uncertain.

Source: The Economic Implications Of Quantifying Policy Uncertainty