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Measuring uncertainty: Overall economic policy vs. monetary policy

Since the start of the pandemic, the word “uncertainty” has dominated conversations about the U.S. economic outlook. It wasn’t clear how the novel coronavirus would affect the economy, and it wasn’t clear what policies would be necessary to counteract its effects. More recently, supply chain issues, the Russian invasion of Ukraine, and a fiscal-stimulus-driven rise in consumer demand have propelled inflation well beyond what many expected last year. And there’s substantial uncertainty about the Federal Reserve’s ability to bring this inflation back under control in a timely fashion.

Quantifying policy uncertainty, however, is tricky. Fortunately, we have the Baker-Bloom-Davis (BBD) Economic Policy Uncertainty Index and its sub-index that specifically targets uncertainty associated with monetary policy.

The FRED graph above plots both indexes from January 2020 to the latest available data point: the BBD Economic Policy Uncertainty Index for the United States (in blue, overall uncertainty) and the Categorical Index for Monetary Policy (in red, specifically monetary policy). A higher index value indicates higher policy uncertainty.

As expected, both indexes jumped in March 2020 as a reaction to the pandemic. As policies were enacted, policy uncertainty broadly declined, especially for monetary policy. But as inflation started to pick up in 2021, monetary policy uncertainty rose and has been moving closely with the overall policy uncertainty index, suggesting that uncertainty around monetary policy, vis-à-vis historically high inflation, has been the dominant force behind overall economic policy uncertainty.

How to create this graph: Search for “Economic Policy Uncertainty Index for United States”: It’s likely your first result is the series you want. Click on the “1 other format” dropdown and choose “Monthly, Index, Not Seasonally Adjusted.” From the orange “Edit Graph” panel, navigate to the “Add Line” tab, search for “Economic Policy Uncertainty Index: Categorical Index: Monetary Policy,” and click “Add data series.” Modify that index’s frequency to monthly in the “Edit Lines” tab if necessary.

Suggested by Michael McCracken and Trần Khánh Ngân.

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