Does uncertainty cost the economy jobs? Fed researchers call it a big problem
September 19, 2012
The Christian Science Monitor
For several years many Americans have said uncertainty is holding the economy down. Now some researchers are pointing to evidence that the problem is a large one.
A mood of doubt – including uncertainty about things like future tax policies – may be to blame for a large share of America's unemployment problem, researchers at the Federal Reserve Bank of San Francisco conclude in a report released Monday.
"Our model estimates that uncertainty has pushed up the US unemployment rate by between one and two percentage points since the start of the financial crisis in 2008," write Fed economists Sylvain Leduc and Zheng Liu. "To put this in perspective, had there been no increase in uncertainty in the past four years, the unemployment rate would have been closer to 6% or 7% than to the 8% to 9% actually registered."
Given that unemployment is usually around 5 percent even in good times, their analysis suggests that as much as half the spike in unemployment since 2008 relates to uncertainty of one kind or another, felt by consumers and businesses.
That translates into lots of jobs. For a reference point, employer payrolls in the US have expanded by about 2 million workers over the past year, as the unemployment fell by 1 percentage point.
The study sheds light on an issue that's already in the public eye. In the presidential election, critics of President Obama say he failed to provide clarity on several vital fronts – from the direction of tax policy and the national debt to whether an increase in regulatory legislation will continue if voters grant him a second term.
"Washington’s policies are not meeting our country’s fiscal challenges and are prolonging uncertainty among small businesses,” economist Martin Regalia of the US Chamber of Commerce wrote in July, for example, adding to an already loud drumbeat from the business community.
The research report, published by the San Francisco Fed, isn't an argument in favor of a particular fiscal policy, or against Mr. Obama's reelection. For one thing, Fed employees steer clear of offering policy advice outside the Fed's own sphere of monetary policy. Also, the report's definition of "uncertainty" is broad, going beyond what a president can control.
But one implicit message in the report is that it would help the economy if the president and Congress can clarify what will occur at the end of this year, when a "fiscal cliff" of tax hikes and spending cuts is scheduled to take effect. Businesses and consumers are widely expecting that policymakers won't send the nation fully "over the cliff" come January, but it's unclear what will actually happen and when.
Already, according to some news reports, concern about the fiscal cliff may be affecting the behavior of businesses and consumers.
"The nonpartisan Congressional Budget Office estimates that uncertainty about the fiscal cliff alone could reduce U.S. economic growth by 0.5% in the second half" of the year, Fortune magazine's Geoff Colvin wrote recently. In an economy growing at an annual rate below 2 percent, "that's a lot, representing billions of dollars that won't be available to hire people."
It would also help if policymakers could settle on a course of action on taxes and federal spending over the next few years.
The researchers used some statistical sleuthing in their bid to quantify the impact of uncertainty. They drew on data going back to 1978, in which a University of Michigan survey has polled respondents each month on whether they expect an “uncertain future” to affect their spending on durable goods such as cars.
"We use the timing difference between the survey [interviews] and data [on the real economy] to build what might be thought of as a small statistical laboratory," the Fed researchers say in the report. "This allows us to measure how, all else equal, an unexpected increase in uncertainty would affect unemployment, inflation, and the nominal interest rate."
They conclude that a spike in economic doubts reduces demand in the near term, such as consumer spending and business investment. The researchers say the resulting slack in the economy creates wiggle room for Federal Reserve policymakers: The Fed can use easy monetary policy, to try to counterbalance the effects of uncertainty, without much fear of sparking inflation.
Fed Chairman Ben Bernanke made a similar case last week, in announcing a new round of "quantitative easing."
"We don't anticipate the economy is going to be overheating anytime soon," Bernanke said in a press conference. "We think inflation will remain close to our 2 percent [a year] target."
One challenge is that Fed policy may not be as effective now as in other circumstances. The central bank has already been holding short-term interest rates near zero for several years, making it hard for additional easing to exert much force.
This constraint on the Fed's power, the San Francisco researchers say, means that "high uncertainty has been a greater drag on economic activity in the Great Recession and recovery than in previous recessions."
Some argue that the economy needs more stimulus from fiscal policy, in the form of tax cuts or spending on things like infrastructure. That's a hot debate that the new Fed research doesn't settle.
Skeptics say fiscal policy becomes less effective in the conditions that exist today, with fast-rising national debt that could become its own drag on growth. Supporters say greater effort at fiscal stimulus could be paired with a medium- or long-term plan to reduce federal deficits.