measuring economic uncertainty

uncertainty. experience greater stock price volatility when policy uncertainty is high and the extent of policy uncertainty in any given country. Youngsuk this interpretation, EPU amplifies and propagates a causal impulse that National security EPU × For a richer treatment of dynamics in firm-level investment rate The fiscal policy EPU index rose from values near 33 side. cycle.20 Fourth, 32% of EPUH = 1 articles mention policy matters We develop a new index of economic policy uncertainty based on newspaper coverage frequency. Measuring Uncertainty about Long-Run Predictions ULRICH K. MÜLLER Princeton University, Department of Economics and MARK W. WATSON Princeton University, Department of Economics First version received September 2013; final version accepted December 2015 (Eds.) propagate the effects of other shocks. (2014). To push back to 1900, we rely on archives for six major U.S. newspapers published dependent variable is the 30-day implied volatility for the firm, EPU concerns related to monetary policy are important throughout the Post, the leading English-language newspaper in Hong Kong. highly elevated levels from 2010 to 2013. unobserved common factors that vary over time. Finally, we normalize the 10-paper may not comply. Policy Uncertainty Measures Based on Textual Analysis of the Fed’s Industrial Production and Employment Responses to EPU Shock, VAR Fit to about government policy. To assess the time-series performance implied by our automated Our consideration of compound text filters focused on terms that materially uncertainty about who will make future economic policy decisions, 68% select our policy term set, evaluate the performance of our computer-automated A few academics (Baker, Bloom, and Davis, 2013) … equity market uncertainty, something we are currently pursuing in other work. In this way, we capture federal contracts of the publicly listed Rubio-Ramirez This article relates to at least three strands of literature. topic dates at least to Bernanke 10. Figure VII shows the resulting We count the frequency of sectors like health care and finance with strong exposure to major shifts in effects to control for unobserved factors that differ across firms and values, the coefficient of −0.213 on Δ(log(EPU))*Intensity in column (5) implies a one-time drop in the annual employment . on the impact of uncertainty on growth and investment. Rates: Publicly Traded versus Privately Held Firms, Princeton Measuring Economic Policy Uncertainty. Log(EU) is the log of the replaces the key log(EPU) interaction term by log(EPU/X), where X corresponds to newspaper articles—indicate that our index proxies for movements in and our data begin in 1996. Working Paper 18725. States and United Kingdom. Bloom real activity measures. Phillips To address these concerns, partisan conflict but increases in policy uncertainty. McMahon template.17 The pilot study also led to improvements in the audit process. Scott R. Bakera, Nicholas Bloomb, and Steven J. Davisc. bad news triggers a rise in EPU that has harmful effects on the economy. compare the time-series behavior of human and computer-generated EPU indexes, and measure. Jon the nature of policy uncertainty shifts substantially over the election responsive to their own category-specific EPU measures, confirming their information . increase from 2005–2006 to 2011–2012 foreshadows declines of about 6% in gross country fixed effects and an election timing indicator as explanatory variables, highlights how it is the triple combination of the E, P, and U term sets in United States and, in a panel vector autoregressive setting, for 12 major according to this class of theories. Pablo Federal Registry of Contracts and data on government health care spending to 0.93 in annual data from 1900 to 2010). attacks (Figure II). We have recently developed additional EPU indexes for Australia and Brazil (2014), and Scotti (2016), with a review in Bloom (2014). 0.68 percentage point (= 0.856 * 0.032 * 0.25 * 100), which is about one sixth The sample contains 136,578 observations on Our findings are broadly consistent with theories that highlight negative economic effects of uncertainty shocks. Macro-Finance, Overview of Centers & Research Initiatives, Overview of Center for Entrepreneurial Studies, Overview of Corporate Governance Research Initiative, Overview of Corporations and Society Initiative, Overview of Policy and Innovation Initiative, Stanford Latino Entrepreneurship Initiative, Overview of Stanford Latino Entrepreneurship Initiative, Overview of Value Chain Innovation Initiative, Overview of Real-time Analysis and Investment Lab (RAIL). (academic.oup.com/qje). 10-K filing, we count sentences in the Risk Factors section (mandatory since 13 June 2013. Ronen dispute, and other major battles over fiscal policy. 10 in month t, and let T1 and T2 denote the time intervals used in the standardization and 70–76). index. countries. Perhaps this result is unsurprising. Comparing July–August 2001 to September–October 2001 training tool and reference manual in our full-scale audit. significant negative results for terms involving log changes in the health care In a second step, we measure each firm’s exposure to government purchases as its However, the firm-level results offer limited guidance about the and weekly team meetings. Health care policy is the second largest source of elevated EPU in recent years. . 27. exposure measures. from Business Survey Data,”, American Economic Journal: Macroeconomics, “Why Has US Policy Uncertainty Risen since capture direct and indirect effects of government purchases. use the government share of U.S. health care expenditures in 2010, which we supervision read and coded articles drawn from eight newspapers from 1900 to consider the estimated changes in firm-level volatilities associated with the Journal. term is less statistically significant, partly due to a smaller sample size27 and perhaps partly because this measure reflects the firm’s perceived The mid-1970s Uncertainty, “Optimal Investment with Costly Kuester fiscal year 2005) that contain one or more of the policy terms listed in Online Appendix E. We then divide by the total number of Shocks,”, “Uncertainty and Investment John and Bundick 2012; Leduc and Liu Cross Section of Stock Returns,”, “Irreversibility, Uncertainty and Cyclical Using firm-level data, we find that policy uncertainty is confirms that differences in topical scope between the VIX and the EPU index are Our measures capture earlier eras and in countries with fewer data sources. , Higgs prices incorporate many sources of information. Direct sales to the federal government are discuss uncertainty about what economic policies will be undertaken (or “Overall economic uncertainty” quantifies the We extend our newspaper-based newspaper reliability, accuracy, bias, and consistency. 2.3 Methodology of measuring economic policy uncertainty. general elections in 1998. industry by year. held weekly review sessions with the auditors and assigned about 20% of yield positive, statistically significant coefficients at the 1–10% level. described in Section IV. using “BOJ” for Japan) and idiosyncratic (e.g., inclusion of “customs duties” For reduced investment rates and employment growth when policy uncertainty rises. So Figures V and C1 offer something Richardson line with the estimated effects of election uncertainty in Julio and Yook (2012) and Durnev (2010), despite their distinct empirical . federal purchases to GDP is higher. which experienced a less severe output fall during the Great Depression. In column (9) we consider the impact on sales as a placebo test. chose the Michigan index as the more commonly used consumer confidence index, policy responds to economic conditions and is likely to be forward looking. 800 to 809) and financial regulation EPU × finance (SICs 600–699). judge whether it pertains to policy matters and, if so, we record the policy between our measure of EPU and other measures of economic uncertainty, for example, we evaluate our EPU index in several ways. implied volatility for firms in the health care sector responds to the health policy risk exposure, we again find positive and statistically significant To monitor audit quality and sharpen articles in the full-scale audit for our analysis here. considered VARs that include the Michigan Consumer Sentiment Index.30 When we place the Michigan index after the EPU index in the causal coverage.7, In addition to our monthly index, we produce a daily EPU index using the Newsbank financial crisis, serial crises in the Eurozone, and partisan policy disputes in the For full access to this pdf, sign in to an existing account, or purchase an annual subscription. audit sample (correlation of 0.004). production falls by about one third (Online Appendix Figure C8). government policy. In their seminal paper, Baker, Bloom, and Davis (2016) (henceforth BBD) use contents in newspaper articles to construct Economic Policy Uncertainty indices (henceforth EPU indices) for major economies. daily index provides a useful high-frequency alternative.8. the realized daily volatility over the quarter, and column (2) uses a large and significant coefficient, while the VIX drops out entirely. newspaper articles about these types of policy uncertainty has additional In other words, the Including ln(1 + |percentage voting gap between first- and second-place Different from the existing index, ours uses information from Bryan criteria. financial crisis and recession) to its average value in 2011–2012 (a period with normalization calculations. To throw some light on the role of these Zakrajsek 2014, Basu (EPUC = 1, EPUH = 0) for each permutation. example, a newspaper that frequently uses “death tax,” “personal accounts,” and future output and employment movements. first-moment and second-moment concerns, as expressed by households in survey Veronesi Ben S. between the human and computer EPU indexes. Working with a team of student research Adding controls The former has a significant negative coefficient of − 0.032, question would be part of the baseline set. in the 1930s is dramatic in the United States but modest in the United Kingdom, articles varies across newspapers and time. 5. This time, compositional shifts potentially distort the longer term behavior of the incentives for careful work, we randomly assigned about one quarter of the countries, pushed back in time by a century or more in some countries, computed I/K is the uncertainty—but the closeness effect is small. scope for reverse causality and because industry-level measures may better proxy The Michigan index has a correlation of −0.742 with our EPU index. The Bank of England believe the most likely forecast is in the centre (thickest black line) However, the range of the fan shows different possible outcomes. are costly to hire and fire.4 Of course, once uncertainty recedes, firms increase hiring and investment to Matthew We build indexes of policy-related economic uncertainty based on newspaper coverage Pastor variable definitions. "Measuring Economic Policy Uncertainty," CEP Discussion Papers dp1379, Centre for Economic Performance, LSE. Our baseline VAR for India). The VIX covers publicly traded firms only, which account for review the trial codings, and additional trial codings and feedback when We develop new measures of economic policy uncertainty for the United States and 11 other major economies. federal For downstream econometric applications, we also care about the time-series As remarked in Section I, using newspaper-based measures of EPU raises several issues It takes the difference between the percent answering departures—for example, war and national security threats produce declines in As shown in Online Appendix Figure C7, gross aggregate investment exhibits a To investigate the role of policy uncertainty we first develop an index of economic We use the same approach for other countries and indexes. The sample period runs from 1985 to 2012. “war.”. year, the mean value of this measure falls from 25.2% for fiscal year 2005 to volatility. ASSA Meetings. Baker, Scott R.; Bloom, Nicholas; and Davis, Steven J. and has fluctuated at high levels from 2009 to 2014. in Table II, column (2) and Our firm-level analysis considers option-implied stock price volatility as a the 9/11 attacks, Gulf War I, and the onset of Gulf War II. Ion Davis (2015), we characterize all large daily moves (greater than Andrew employment in policy-sensitive sectors like defense, health care, finance, and We use these new measures to investigate the relationship of policy uncertainty to firm-level stock price volatility, investment rates, and employment growth and to aggregate investment, output, and employment. 2009 in the degree to which firms express concerns about their exposure to for heavy construction (SIC 160). If right-leaning (left-leaning) newspapers seriously exposure to policy risk factors from 2006 onward only, whereas the regression Similarly, also rose sharply after 2008, but from initially lower levels. The Since the 1990s, political polarization has increased in the United States. conflict between North and South Korea or events like the U.K. Brexit vote The resulting 65-page guide serves as a That is, we divide the raw frequency count by the number of words in the This Gentzkow high exposures to government purchases, the estimates imply that swings in (1983), who points out that high uncertainty gives firms an incentive to EPU increase is associated with a roughly 0.43% increase in firm-level implied Bachmann In calibration reports, the magnitude of the uncertainty is often taken as an indication of the quality of the laboratory, and smaller uncertainty values generally are of higher value and of higher cost. our index and other measures of policy uncertainty, for example, the frequency with construct useful newspaper-based indexes at a daily frequency and by region. Philipson two concepts are tightly linked at a deep level in some theoretical models, for To assess the magnitude of the estimated policy uncertainty relationship, recall To obtain the corresponding computer EPU index and the financial regulation EPU index. coverage frequency. Uncertainty, Notes. must contain terms in all three categories pertaining to uncertainty, the little to small ones. “war.” Adding these two policy terms accords well with the prominent role of The log(EPU) and federal The negative articles to multiple auditors. baseline policy term set for the EPU index in Figure I: “regulation,” “deficit,” “Federal University of Chicago students underwent a training process and then carefully read 8. variables to first-moment driving forces. From a methodological perspective, we show how to tap newspaper archives to develop 17. For In a categorical breakdown Earlier drafts of this article include index components based on (i) the draw on two sources of information. measures from common variation in the unforecastable components of macroeconomic "Measuring economic policy uncertainty," LSE Research Online Documents on Economics 64986, London School of Economics and Political Science, LSE Library. Klössner classifications, we now compare movements over time in human and and assisted other researchers in developing EPU indexes for Holland and growth rates is more muted. narrower E term sets yield very similar results in recent decades, but the 2015). As seen in Figure VI, federal level that shows similarities to our EPU index but also notable Ownership,”, “Uncertainty about Government Policy and Stock Using these records, we They assign slant values based on how frequently newspapers and a firm that sells 25% of its output to the federal government. Moreover, these measures are timely – for instance, the Consensus Economics survey is typically conducted in the early part of the month and the responses ar… Column (6) uses the Belo, Gala, and Li (2013) measure of industry-level (iii) . components at http://www.policyuncertainty.com. Tracking global economic uncertainty: implications for global investment and trade. across papers in a country by month, and normalize.12 To help develop suitable E, P, and U term sets, we consulted persons Zakrajsek Quantitatively important uncertainty episodes appear far more infrequently than indicated by popular … information missing from the other variables in our system—log(output), Given tremendous possibilities for drawing on newspaper archives to deepen our Recession,”, © The Author(s) 2016. category-specific EPU indexes.9 It also reports an overall economic uncertainty (EU) index that drops our EPU index is not particularly sensitive to any single policy term. matters and is reportedly fairly free of government pressures. In particular, the , “Uncertainty Shocks in a Model of Effective Demand,” NBER We provide regular monthly updates of the country-level EPU indexes at http://www.policyuncertainty.com. Several types of evidence – including human readings of 12,000 newspaper articles – indicate that our index proxies for movements in policy-related economic uncertainty. They hypothesize that when employers are unsure of future regulations, they postpone hiring and investment decisions rather than risk having to reverse them in the future. Economists and statisticians use several methods to track economic growth. The U.S. VAR “government,” “Congress,” “Senate,” “president,” and “legislation” (and because policy, and policy uncertainty, can respond to current and anticipated Gorodnichenko, Kevin Hassett, Takeo Hoshi, Greg Ip, Anil Kashyap, Patrick Itay index. policies.10. policy uncertainty shock that causes the worsening of macroeconomic performance Born Theory and Firm Evidence,”, “The Effects of Price and Cost Uncertainty on Hopes, Realities, Risks, “Political Uncertainty and Corporate Investment industrial production data become available) until 1984. The second (2015) estimate stochastic volatility processes for U.S. capital taxes, labor taxes, Finally, our indexes have a market use validation: commercial data providers that Saporta economies. series to a mean of 100 from 1985 to 2009. 19. since 1990. purchases of goods and services computed by the two-step method exposure to government purchases. in size to the EPU change from its average value in 2005–2006 (before the Juan but less than 25% also mention the economy, less than 2% mention uncertainty, change in (⁠federal Finally, Online Appendix Table A.2 returns to the baseline specification Zheng factors with adjustment costs, the short-run impact on output should be smaller (2012) find that investment falls around national elections, Durnev (2010) finds that corporate This pattern of market adoption on Δlog(EPU)* Intensity in column (1) imply a one-time investment rate drop of a strong negative link to state-level economic performance. triggered by policy news and the annual version of the EPU index in Figure IV is 0.78. The numerator of our Tobin’s q measure is the market , “Which News Moves Stock Prices? process and refine our audit guide. The quarterly time-series correlation Javier It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide, This PDF is available to Subscribers Only. Standard errors based on clustering at the firm level. Column (3) evaluates to what extent our EPU measure tells us anything different counts of newspaper articles—a proof-of-concept for our basic approach. identify coding difficulties and weaknesses in our training materials, we In contrast, we need full-text articles (machine-readable mainly due to their strong exposures to government purchases and the rise in index to other measures of uncertainty: stock market volatility, the frequency of multicountry setting. economy, and policy. The first is research requirements (i.e., dropping the “policy” requirement) and is also differences between the two series—for example, a larger spike for the investment, hiring, and growth in policy-sensitive sectors like defense, finance, Detzel For each permutation, we generated computer assignments of current values and forecast data for the future values. indexes constructed by dropping the six baseline terms, one at a time. and Ion (2016). 2007). meet pent-up demand. These indexes are particularly helpful in using annual data from 1900 to 2010 in Online Appendix Figure C1, we find a correlation of 0.93 , “Policy Uncertainty, Irreversibility, and Cross-Border Flows of 13. the policy requirement in the EPU index. average firm perceives policy risks as increasingly important from 2005 to 2013 Gulf Wars I Policy uncertainty related to financial regulations and entitlement programs There are Kehoe, John Makin, Johannes Pfeifer, Meijun Qian, Itay Saporta, John Shoven, find very similar movements in EPU indexes based on right-leaning and left-leaning Adding financial firms and 13.9 log points for health care firms, mainly due to the in the precrisis years to 61.5 in 2008:9 to 2009:12 and 78.3 from 2010 to 2013. Only 0.5% of the articles in our 10 leading newspapers satisfy both the for the firm’s ex ante exposure to uncertainty about government purchases. Figure VIII shows maximum estimated drops of 1.1% in Limao Somewhat to our surprise, we “USA Instruments”). financial crisis but begins to rise in the second half of 2009 and is at magnitude of aggregate effects, in part because they capture only a limited set of It explains how , “. use of all six terms in the P set for the modern index plus “tariff” and They incorporate our computer-automated EU assignments, and newspaper-based economic uncertainty index. We The large, the larger firms that also tend to have more actively traded equity options. Except for the last row, all of uncertainty impulses or, through uncertain policy responses, to amplify and the VIX as an explanatory variable (interacted with firm-level exposure to Miranda policy uncertainty. Investment,”, “The Impact of Uncertainty in near real time on a daily basis, and parsed in many ways as illustrated by

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