RDP 2016-01: Measuring Economic Uncertainty and Its Effects 5. Conclusion

A newly constructed monthly economic uncertainty index lines up well with events that would be expected to increase uncertainty and with other proxies of economic uncertainty. Based on the index, economic uncertainty rose to historically high levels during the global financial crisis and remained above long-term average until late 2013. It was a bit below average for all of 2014.

I use the index to document some stylised facts about economic uncertainty in Australia. In particular:

• Economic uncertainty is estimated to be countercyclical. It is about two-thirds of a standard deviation higher when unemployment is rising.
• Both foreign and domestic factors matter for uncertainty in Australia.
• Economic uncertainty tends to increase faster than it decreases and periods of high or low uncertainty tend to persist.

I also use the index to estimate how uncertainty affects the economy. I find that higher uncertainty:

• weighs on employment growth
• reduces machinery and equipment investment growth
• raises the household saving ratio.

In summary, I find that heightened uncertainty weighs on economic activity, and does so in ways broadly consistent with theories about the effects of economic uncertainty. Given these effects, economic uncertainty is worth considering in policy and empirical work.