Uncertainty and the Recession

A recent paper by Lawrence Mishel at the Economic Policy Institute attracted attention. It attacked the popular view that "regulatory uncertainty" was holding the economy back. There was no convincing evidence for this, it argued. Trends in investment (this recovery, weak as it may be, has been "investment-led" by historical standards), in hiring, and in hours worked all suggested that lack of overall demand is the problem.

I thought the paper was clever and interesting but not all that persuasive.

First, the focus on regulatory uncertainty seemed too narrow. What about other kinds of policy-induced uncertainty? Second, its target--the idea that regulatory uncertainty as opposed to weak demand is the cause of slow growth--is a straw man. Who is denying that weak demand is a factor, or even the larger factor of the two? We can agree that weak demand is the main problem, and still think that business uncertainty over economic policy is making things worse. Mishel's findings don't address that.

Third, the paper seems to take it for granted that business uncertainty affects business choices but not consumer choices. If businesses are complaining loudly about a hostile policy climate, and the news is full of reports about the incapacity of Congress, debt downgrades, constitutional challenges to healthcare reform, and endless inconclusive battles over spending cuts and tax increases, wouldn't you expect that to affect consumer confidence as well?

Mishel quotes a Bloomberg editorial with approval:

[T]here is no evidence that uncertainty has increased during the Obama presidency, or that, if it has, the president's policies are responsible for it.

The question is not just whether uncertainty has increased since the start of 2009, but whether it has fallen from the historic highs of that point as much as it could have and should have. The editorial, which rightly says that creating uncertainty has been central to the Republicans' electoral strategy, is not entirely clear on the point. The debt-ceiling debate, I'd say, raised uncertainty to new and extraordinary levels. And the administration was not free of blame in that fiasco.

This new column for Bloomberg by Scott Baker, Nicholas Bloom and Steven Davis, sums things up pretty well. Their data suggest persistent, exceptionally high levels of "policy-induced" uncertainty. This, they say,

reflects deliberate policy decisions, harmful rhetorical attacks on business and "millionaires," failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.

They also explain that policy-induced uncertainty can work through consumption as well as investment and hiring. It isn't the only thing holding the economy back, but that does not make it insignificant.

So how much near-term improvement could we gain from a stable, certainty-enhancing policy regime? We estimate that restoring 2006 levels of policy uncertainty would yield an additional 2.5 million jobs over 18 months. Not a full solution to the jobs shortfall, but a big step in the right direction.