Quantifying Economic Policy Uncertainty

Is economic policy muddled? Some economists argue that confusion on the outlook for a range of policy fronts, such as regulation and tax policy, has been weighing on the economy. But how does one define policy uncertainty? A Stanford economist (Nicholas Bloom) and a Ph.D. candidate (Scott Baker) offer a possible solution with an attempt to quantify the concept in a new benchmark: Index of Economic Policy Uncertainty (EPU). According to the index’s latest data through January, U.S. policy uncertainty has fallen sharply.

Commenting on the drop, Baker and Bloom advise:

Alongside the sudden drop in policy uncertainty, economic prospects in the US appear to have improved considerably. Last Friday’s announcement of a 250,000 drop in unemployment led to a surging stock market as investors began to believe the recovery had finally begun. Our research suggests this has been aided by the calming of policy uncertainty.

Unfortunately, policy uncertainty still appears extremely high in Europe with the Eurozone crisis. When this finally calms down, European growth should then have additional impetus to recover.

Compared with the pre-2008 era, however, policy uncertainty remains elevated, as the chart below shows. Nonetheless, the recent decline is pronounced, suggesting that the future is considerably less murky these days vs. last year’s second half. Last October, Baker and Bloom warned that “Policy Uncertainty Is Choking Recovery.”

The EPU index is calculated from a mix of policy related references in news stories and other data, such as the number of tax laws expiring in the near-term future and predictions of government spending. For the details and the data, along with a new white paper on the index, visit the EPU’s web page: www.policyuncertainty.com/Home.html