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A precise measure of uncertainty?

The Economic Policy Uncertainty Index tries to quantify unpredictability

FREDcast, FRED’s forecasting game, asks players to forecast four major macroeconomic variables by the 20th of every month. Some players may be frustrated by the erratic behavior of some of these indicators as they attempt to make their guesses. Fair enough. Plenty of other data analysts are in the same boat. Well, a team of researchers has been trying to quantify this sense of uncertainty using the Economic Policy Uncertainty Index, graphed above for the world’s five largest economies.

And how, exactly, does one transform a feeling into a number? According to the researchers, articles from major newspapers are analyzed for mentions of uncertainty related to aspects of economic policy, including the decisionmakers themselves, the actions undertaken, and the effects of those policies. The number of articles expressing uncertainty is standardized to the total number of articles written by each source; the accuracy of the resulting index is then tested by making comparisons with relevant indexes constructed through other methods.

The index associates historical events with the economic data. For example, the first significant spike outside of a recession in the above graph shows up in the first quarter of 2003. The spike is highest for Europe and occurred when 10 European countries were in talks to join the European Union under the condition that they’d eventually join the eurozone. The media covered these discussions in a way that uncertainty regarding policymakers, policies, and their effects came across in the index.

In 2008, as the financial crisis was unraveling, there was still much debate on what policies should be adopted and how effective those policies might be. This translated into an elevated index. Soon after, in 2011, the index spiked again in all countries. It’s likely that the uncertainty surrounding the economic and political events at the time, such as the European sovereign debt crisis and the U.S. debt-ceiling discussions, was captured by the index in this case as well.

After 2011, many nations appear to have maintained high levels of economic policy uncertainty that well surpass levels before the Great Recession. The impact of Britain’s vote to leave the European Union, several significant elections around the world, and similar newsworthy events are plainly visible in the all-time highs of the index in the past two years. If you’re not doing too well on FREDcast, you can use the pretty good excuse that there’s certainly a lot of policy uncertainty out there.

How this graph was created: Search for “economic policy uncertainty” and check the boxes next to the monthly series for the United States, Europe, China, India, and Japan. Select “Add to Graph.” Adjust the time range to begin in 1990.

Suggested by Maria Hyrc and Christian Zimmermann.


Shaking things up in China

During President Obama’s recent visit to China, even getting off the plane involved political upheaval: The New York Times described the mood as “tense” when disagreements between Chinese and U.S. officials compelled the president to use an alternative stairway to deplane Air Force One.

Chinese economic policy has also been tense for some time now, independent of their ability or willingness to accommodate a foreign 747. The graph above plots the Economic Policy Uncertainty Index from Baker, Bloom, and Davis for the U.S. and China. This index scans news articles about a country and records the frequency of phrases that connote economic policy uncertainty. When it’s high, the press is using language that suggests the government could change its regulations, spending, and/or taxes in the near future. As the authors point out, this uncertainty complicates planning and can adversely affect investment. It can also, however, reflect economic conditions themselves; as the economy sours, the political response is often uncertain as sides debate how best to respond.

Until recently, China and the U.S. tracked each other quite well, and such a connection might reflect common economic conditions in the two countries. But China did not share the U.S. experience during the 2001 recession; it shared only the rise in uncertainty. The bottom graph adds GDP growth to the mix, and the “pattern” we see has almost no pattern to it. GDP is slowing in China, but policy uncertainty seems to be hyperactive. Chinese GDP declined during the Great Recession, and since then the decline seems to have been smooth and slight. Policy language, however, has vacillated quite wildly. Perhaps President Obama should feel lucky his stairway remained in place as he descended.

How these graphs were created: Top graph: Search for “Economic Policy Uncertainty Index” and select the U.S. and China among the countries given. Convert both to a quarterly frequency for two reasons: The frequency of U.S. GDP is also quarterly, and the monthly swings in the Chinese index are so great they make it difficult to visualize the U.S. index. Bottom graph: Add two lines to the top graph: seasonally adjusted real U.S. GDP (converting it to a percentage change) and constant China GDP, which should give the U.S. dollar-denominated GDP (again, converting it to a percentage change). For both these new lines, go to the “Format” tab in the “Edit Graph” section and move the units to the right vertical axis. Note: FRED doesn’t have updated Chinese real GDP after 2014, but the latest figure from the National Bureau of Statistics in China puts growth at 6.7% in 2016:Q2, slightly lower than the 7.3% recorded in 2014, as shown in the graph.

Suggested by David Wiczer.

View on FRED, series used in this post: CHIEPUINDXM, GDPC1, RGDPNACNA666NRUG, USEPUINDXM

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