We find three preliminary results:

1. Measuring Economic Policy UncertaintyScott R. Baker (Stanford)Nick Bloom (Stanford & NBER)Steve Davis (Chicago Booth & NBER)Hoover Institution, Friday December 2nd 2011

2. The paper tries to investigate the claim that policy uncertainty contributed to the recession of 2008-2009 We find three preliminary results: • Policy uncertainty fluctuates over time, and since 2008 has reached all-time high levels • Policy uncertainty is now a large (and probably the largest) driver of overall economic uncertainty • Policy uncertainty appears to lower economic growth and raise stock-market volatility

3. The paper tries to investigate the claim that policy uncertainty deepened the recession of 2008-2009 We find three preliminary results: • Policy uncertainty fluctuates over time, and since 2008 has reached all time high levels • Policy uncertainty is now a large (and probably the largest) driver of overall economic uncertainty • Policy uncertainty appears to lower economic growth and raise stock-market volatility

4. Debt Ceiling; Euro Debt Figure 1: Our main index of policy uncertainty Banking Crisis, Obama Election Euro Crisis, 2010 Midterms Lehman and TARP 2nd Gulf War Large interest rate cuts, Stimulus 1st Gulf War Clinton Election 9/11 Balanced Budget Act Policy Uncertainty Index Bush Election Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis, November 2011, at http://faculty.chicagobooth.edu/steven.davis/pdf/PolicyUncertainty.pdf.

5. Our economic policy uncertainty index is built from three sub-components • Newspaper coverage of policy-related economic uncertainty • Number of federal tax code provisions set to expire • Disagreement among economic forecasters over future: • levels of the CPI • federal government purchases of goods & services The overall index is constructed from a 50% weight on the broad newspaper index and equal weight on the others (but results are pretty robust to different weighting measures)

6. Sub-component 1): News-based policy uncertainty index Debt Ceiling; Euro Debt Obama Election, Banking Crisis Euro Crisis, 2010 Midterm Lehman and TARP 2nd Gulf War 9/11 Interest Rates, Stimulus Policy Uncertainty News Index 1st Gulf War Clinton Election Bush Election Russian Crisis/LTCM Notes: Frequency of the triple of “economy/economic”, “uncertain/uncertainty” and one of a collection of policy terms (policy, regulation, federal reserve tax, spending, budget and deficit) in US Google news normalized by the smoothed frequency of the word “today”. Normalized to 100.

7. Check of news based indices example: tracking financial uncertainty Lehman Bankruptcy Financial Uncertainty Index Russian Crisis/LTCM Black Monday 9/11 Asian Crisis 2nd Gulf War 1st Gulf War Notes: Frequency of the triple of “economy/economic”, “uncertain/uncertainty” and one of a collection of financial market terms (e.g. stock price, equity price, stock market etc ) in US Google news normalized by the smoothed frequency of the word “today”. Both series scaled to same mean.

8. Check of news based indices example: tracking war and terror uncertainty 2nd Gulf War 1st Gulf War 9/11 War and Terror Uncertainty Index Bush Election Notes: News-Based War and Terror Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty as well as the term ‘war’ or ‘terror’ (scaled by the smoothed number of articles containing ‘today’). Google query run June 15, 2011. Index covers January 1985-May 2011

9. Sub-component 2) Tax expiration index Tax Legislation Expiration Index Notes: Utilizes List of Tax Expirations from the Joint Committee on Taxation. Each year’s forecast is a 10-year horizon of expiring tax laws. Future expirations weighted by 0.5^((T+1)/12)where T is the number of months until the tax expires

10. Our dollar (rather than equal) weighted tax expiration index shows an even steeper rise Indexes of Scheduled Tax Code Expirations Based on CBO Data, Preliminary

11. Sub-component 3a): CPI disagreement index Obama Election, Banking Crisis Balanced Budget Act Budget Battle 1st Gulf War 2nd Gulf War/ Fed Drops Interest Rates Clinton Election CPI Forecasters IQ Range Index Notes: From the Philadelphia Federal Reserve Survey of Professional Forecasters. Takes the interquartile (IQ) range of the 1-year ahead forecasts (made every quarter) of total federal government expenditures relative to the mean forecast. Normalized to a mean 100 indexprior to Aug 2011.

12. Sub-component 3b): Federal expenditure disagreement Balanced Budget Act Budget Battle Clinton Election Obama Election, Banking Crisis Federal Expenditures Forecasters IQ Range Index 9/11 Notes: From the Philadelphia Federal Reserve Survey of Professional Forecasters. Takes the interquartile (IQ) range of the 1-year ahead forecasts (made every quarter) of total federal government expenditures relative to the mean forecast. Normalized to a mean 100 indexprior to Aug 2011.

13. Policy uncertainty fluctuates over time, and since 2008 has reached all time high levels • Policy uncertainty is now a large (and probably the largest) driver of overall economic uncertainty • Policy uncertainty appears to lower economic growth and raise stock-market volatility

14. Figure 6: Overall & Policy-Related Economic Uncertainty Gulf War I Dissolution of USSR Bush Election Recession Fears Clinton Election Russian Financial Crisis/LTCM 1987 Stock Market Crash Recession Fears Asian Financial Crisis Normalized Number of News Articles Notes: Overall News-Based Economic Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty as well as economic or economy (scaled by the smoothed number containing ‘today’). Policy Index set such that monthly average value is 100. Index covers January 1985-July 2011. Axis shown as a log scale. Query run on August 11, 2011.

15. Note: analysis uses Google news index data

16. Another indicator of the importance of policy uncertainty is it now seems to be the most frequent factor causing stock-market jumps

17. Frequency of 2.5% or greater jumps in the S&P 500 stock market index and the factors underlying this

18. Policy uncertainty fluctuates over time, and since 2008 has reached all time high levels • Policy uncertainty is now a large (and probably the largest) driver of overall economic uncertainty • Policy uncertainty appears to lower economic growth and raise stock-market volatility

19. Why might uncertainty impact the real economy? Economics literature has mainly focused on three channels: “Real-options effects”: Uncertainty can make firms cautious about investing and hiring “Financing costs”: Uncertainty can increase risk-premia “Precautionary savings”: Uncertainty can reduce consumption

20. Figure 8: VAR Estimated Industrial Production and Employment changes after a Policy Uncertainty Shock Notes: This shows the impulse response function for Industrial Production and employment to an 124 unit increase in the policy-related uncertainty index, the increase from 2006 (the year before the current crisis) until the first 8 months of 2011. The central (black) solid line is the mean estimate while the dashed (red) outer lines are the one-standard-error bands. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log industrial production and time trend. Data from 1985 to 2011. Industrial Production Impact(% deviation) Months Employment Impact(millions) Months

21. Policy uncertainty also seems to make stock markets more risky (as stocks move together more) Reproduced from “Political Uncertainty and Risk Premia,” by Lubos Pastor and Pietro Veronesi, University of Chicago, 20 November 2011. “Political Uncertainty Index” is the Economic Policy Uncertainty Index from Baker, Bloom and Davis.

22. Conclusion We are developing a methodology to try and measure economic policy uncertainty over time, with three preliminary results: Policy uncertainty since 2008 has been at all time high levels Policy uncertainty is now a large component (potentially the largest component) of general economic uncertainty Higher policy uncertainty is followed by reduced growth over the following 18 months and increased stock co-movement Continuing to refine the index and extend it back to about 1900

23. BACK-UP SLIDES

24. More on Economic Policy Uncertainty Paper: “Measuring economic policy uncertainty”, Scott Baker, Nick Bloom and Steve Davis, Stanford mimeo http://www.stanford.edu/~nbloom/PolicyUncertainty.pdf “Policy Uncertainty and the Stalled Recovery,” Scott R. Baker, Nicholas Bloom and Steven J. Davis, VOX, 22 October 2011. http://voxeu.org/index.php?q=node/7137

25. Figure 7: Relationship of News-Based Index of Overall Economic Uncertainty to News-Based Index of Policy-Related Economic Uncertainty R-Squared: 0.68 Slope: 0.79 (0.05) R-Squared: 0.88 Slope: 0.98 (0.03) R-Squared: 0.53 Slope: 1.50 (0.19)

26. Figure 9: Robustness of Estimates to Different VAR Specifications Three months of lags Reverse order Baseline Uncertainty index has equal weight on measures Nine months of lags Industrial Production Impact(% deviation) Bivariate (uncertainty and log industrial production) Adding VIX first as a control for economic uncertainty Months after the policy uncertainty shock Notes: This shows the impulse response function for GDP and employment to an 124 unit increase in the policy-related uncertainty index. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log industrial production and time trend unless otherwise specified. Data from 1985 to 2011.

27. Figure 10: Quarterly VAR estimates for GDP and investment GDP Impact(% deviation) Notes: Shows the impulse response function to an 124 unit increase in the policy-related uncertainty index, the increase from 2006 (the year before the current crisis) until the first 8 months of 2011. The central (black) solid line is the mean estimate while the dashed (red) outer lines are the one-standard-error bands. Estimated using a quarterly Cholesky VAR: the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log investment, log consumption and log GDP. Data from 1985 to 2011. Investment Impact(% deviation) Months after the policy uncertainty shock

28. Figure 11: Estimates after including controls for consumer confidence Consumer confidence included second in the VAR Notes: This shows the impulse response function for Industrial Production and employment to an 124 unit increase in the policy-related uncertainty index, the increase from 2006 (the year before the current crisis) until the first 8 months of 2011. The central (black) solid line is the mean estimate while the dashed (red) outer lines are the one-standard-error bands. Estimated using a monthly Cholesky Vector Auto Regression (VAR) of the uncertainty index, log(S&P 500 index), federal reserve funds rate, log employment, log industrial production and time trend. Data from 1985 to 2011. Top panel includes the Michigan Consumer confidence index included as the second variable after our uncertainty index, and the bottom panel includes the Michigan Consumer Confidence index included as the first variable. Industrial Production Impact(% deviation) Consumer confidence included first in the VAR Months after the economics policy uncertainty shock

29. Figure 13: News-Based China and Japan Competition Indexes China and Japan Competition Index Notes: News-Based China and Japan Competition Index composed of monthly number of news articles containing competition and economy and Japan or China (scaled by the smoothed number of articles containing ‘today’). Query run August 26, 2011. Index covers Jan 1985-Aug 2011.

30. Appendix Figure A1: News-Based Energy Uncertainty Index Arab Spring Oil Spike Oil Spike Energy Uncertainty Index 2nd Gulf War 1st Gulf War Notes: Energy Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty as well as the term ‘energy’ (scaled by the smoothed number of articles containing ‘today’). Google query run June 15, 2011. Index covers January 1985-May 2011

31. Appendix Figure A3: News-Based Middle East Uncertainty Index Arab Spring 1st Gulf War Middle East Uncertainty Index 2nd Gulf War 9/11 Notes: News-Based Middle East Uncertainty Index composed of monthly number of news articles containing uncertain or uncertainty as well as the term ‘Middle East’ (scaled by the smoothed number of articles containing ‘today’). Google query run June 15, 2011. Index covers January 1985-May 2011

32. Appendix Figure A4: Equal Weighted Index of Economic Policy Uncertainty Euro Crisis, 2010 Midterms Debt Ceiling; Euro Debt Obama Election, Banking Crash Lehman and TARP Balanced Budget Act Stimulus Debate Policy Uncertainty Index 2nd Gulf War 1st Gulf War Clinton Election 9/11 Budget Battle Bush Election Notes: Index of Policy-Related Economic Uncertainty composed of 4 series: monthly news articles containing uncertain or uncertainty, economic or economy, and policy relevant terms (scaled by the smoothed number of articles containing ‘today’); the number of tax laws expiring in coming years, and a composite of IQ ranges for quarterly forecasts of federal government expenditures and 1-year CPI from the Phil. Fed Survey of Forecasters. Weights: .33 Google News, .33 tax expirations, .167 CPI disagreement, .167 Fed. expenditures after each index normalized to have a standard-deviation of 1. Google query run August 11, 2011, updated Sept 25 and Nov 8. Index normalized mean 100 before Aug 2011.

33. Appendix Figure A5: Principal Component WeightedIndex of Economic Policy Uncertainty Euro Crisis, 2010 Midterms Debt Ceiling; Euro Debt Obama Election, Banking Crash Lehman and TARP Stimulus Debate 2nd Gulf War Policy Uncertainty Index 1st Gulf War 9/11 Bush Election Clinton Election Notes: Index of Policy-Related Economic Uncertainty composed of 4 series: monthly news articles containing uncertain or uncertainty, economic or economy, and policy relevant terms (scaled by the smoothed number of articles containing ‘today’); the number of tax laws expiring in coming years, and a composite of IQ ranges for quarterly forecasts of federal government expenditures and 1-year CPI from the Phil. Fed Survey of Forecasters. Weights: .35 Google News, .37 tax expirations, .24 CPI disagreement, .04 Federal exp. disagreement after each index normalized to have a standard-deviation of 1. Google query run August 11, 2011, updated Sept 25 and Nov 8. Index normalized mean 100 before Aug 2011.

34. Google economic policy uncertainty citation index is highly correlated with a narrower 5-paper index Correlation=0.82 5 paper index is the frequency of “uncertain”, “economic/y” and our key policy terms in the USA Today, Miami Herald, LA Times, Wash Post, and Chicago Tribune, normalized by “today”