Maybe it goes without saying that
the wrangling and indecision among Federal government policymakers would have a
detrimental effect on economic activity.
But a new report by an economic consulting firm we've known well during
our Wall Street years actually puts this in some pretty clear context. There's a measurable impact on employment and
on the risk premium financial markets charge even fairly good quality corporate
borrowers. A separate study from one of
the Federal Reserve Banks highlights the impact on small business expansion
plans, the source of much economic growth in this country.
We're not talking about actual government
policy actions and their impact, but the recent severe and protracted disagreements
in government over what those policies should be. Specific policies, such as tax increases, can
slow the economy, as businesses and/or individual taxpayers set aside more of
their income to pay the government. But
at least they can plan ahead and run their companies or scope out their own
household purchasing and investments with the law in mind. However, if there is disagreement about what
the laws should be, then no one outside government can make any plan. Some people might spend away, trying to get
what they want before government takes their money. But they'd likely hold up any financial
investment decisions or long-range planning.
And businesses too would be hesitant to act. If their specific company is doing well and
they might want to open a new store or even a new plant, they don't want to get
in the middle of such a major project and then see their taxes hiked or their
regulations tightened or, if government spending cuts are being considered,
they don't want to see their contract or grant cancelled in midstream, right
after they've leased their new property or whatever. So, most often, they will hang back and wait to
do anything until they can see what laws are finally enacted. Thus, economic activity would slow below what
it otherwise might be while the policy debates play out.
The Economic Policy Uncertainty Index
This "hanging back"
effect is visible and measurable. Macroeconomic
Advisers, LLC, based in St. Louis, calls our attention to the Economic Policy
Uncertainty Index[1, 2]. This series was
compiled by economists at Stanford and the University of Chicago. It combines three items, a count of news
stories in papers around the country about policy disagreements, a schedule of
tax law changes (such as the expiration of the Bush tax cuts) and measures of the
differences among various professional economists' economic forecasts as they
try to take account of new policies.
Here's a picture of the policy
uncertainty index since 2000. You can
see that its long-term average is 100, but since 2009, it has averaged 150,
that is, 50% higher. You can also see spikes
when this got more extreme: one in September 2001, around 9/11, a second during
the financial crisis of 2008-09, a third in the summer of 2011 over the first
debt-ceiling fight, and the latest one.
The jump we show at the very end is an approximation of October's value
based on a separate daily index of news story counts on these issues, compiled
by the same Stanford and Chicago group.
The Macro Advisers firm has performed
statistical analysis estimating the numerical relationship of the Economic
Policy Uncertainty Index to financial market risk, GDP growth and the
unemployment rate. They find that the
high levels of this index in recent years have resulted in GDP growth since
2009 that is 0.3% lower each year, cutting average growth to 2.1% from the 2.4%
it would have been if policy decisions had been made more promptly. Hitting closer to home, this is associated
with an unemployment rate that has averaged 0.6% higher than it otherwise would
have been. So the unemployment rate that
lately has been 7.2%, would be closer to 6.6%, and there could be as many as
900,000 more jobs by now. Corporate
borrowers in bond markets have paid nearly 0.40% higher in interest costs due
to the policy uncertainty factor alone; this erodes some of benefit of the low
interest rates being fostered by the Federal Reserve's recent bond buying
programs.
Notably, the Macro Advisers
analysis stops in mid-2013, so the very latest episode of policy wrangling is
not yet factored in. We have seen some
estimates that GDP growth in the fourth quarter will be reduced by about 0.5%
from the 17-day government shutdown, not counting the extra uncertainty element
we describe here.
Small Business Gets Hurt Too
Another study of the effect of
policy uncertainty on business came in the summer and fall of 2011 during and
immediately after the upset then over the federal government's debt ceiling and
the credit downgrade by one of the financial rating companies. Publicity at the time about the ramifications
of the disagreements for business plans was based on anecdotes and scattered
commentaries by pundits, politicians and the occasional CEO. Some argued that the developing recovery in
employment and capital spending was being hamstrung, while others said citing the
policy brouhaha was just some sort of excuse. Economists at the Federal Reserve Bank of
Cleveland thus did some work on the relationship of the Economic Policy
Uncertainty Index to small business hiring and expansion plans.[3] Such data from small businesses are collected
monthly through a survey by the National Federation of Independent Business, a
nonpartisan, nonprofit advocacy organization of some 350,000 small businesses
owners.[4]
The Cleveland Fed analysts
calculated statistical relationships between the EPU Index and the NFIB
measures of small business hiring plans and capital spending plans. These regression measures imply that during
the 2011 policy-making debacle, heightened policy uncertainty was associated
with a reduction of 6 percentage points in the share of businesses planning net
increases in the number of employees; so instead of the 4% or 5% actually
reported in the survey, the share could have been 10-11%, closer to the
long-term average of 14%. Recent
readings have been 9-10%, a substandard level surely related to the policy
uncertainty issue. The Cleveland study
calculated a similar 6% cut in the share of businesses planning some form of
construction or capital equipment purchases, holding that at around 22% in 2011
instead of the 28% that might otherwise apply.
The long-run average is 33%.
Recent figures have been about 25%, which is thus also subpar.
Another of the NFIB survey items
asks participants if "now is a good time to expand the
business". That question got yes
answers from an average of 18% of survey participants prior to the economy's
peak in December 2007; it fell, of course, after that, but has not recovered at
all, hovering in a range of 5 to no more than 10% since the middle of
2008. This measure has a decisive 70%
negative correlation with the EPU Index, suggesting that at least some of its
recent sluggishness is tied to the government's disarray.
How Can We Encourage Government To Be More Responsible?
We were going to write an article
for you on the government policy disputes anyway, and an economist friend
lately sent us a note giving us even more inspiration: "You need to write
an article on the hypocrisy and self-interest of politicians who are putting self-interest
ahead of the best interest of their country." As we began our work on these issues, we had
expected that our commentary would be mainly some kind of rant expressing that
view. What we learned in doing our
research the last few days is more substantive: there are in fact real,
identifiable costs to this in terms of fewer jobs and higher financing rates. Small business leaders seem especially
discouraged. These come over and above
the direct costs generated by any actual tax hikes, spending cuts, or most
currently, the 17-day shutdown.
We wish we knew something to do
about it all. We might say, "write
your Representatives and Senators and urge them to respect each other's views
and work together toward middle-ground solutions". So we did say it. Send your letters to your local newspapers;
post them on your Facebook pages; get the word out. More such text might be "stop the
blame-game; that doesn't help anyone".
Finally, "most concretely, can the Conference Committee, chaired by
conservative Paul Ryan and liberal Patty Murray, fulfill their mission to
devise a real budget for the fiscal year that's already a month old?! What do we pay you to do there in
Washington?"
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Labels: Economy, Government Policies
