On macroeconomic uncertainty

Uncertain policymakers!

In this paper, Cieslak et al. examine how policymakers’ perceptions of uncertainty and, in particular, their beliefs about higher-order moments of economic outcomes affect policy decisions. Towards this goal:

• They construct the policymakers’ uncertainty index, namely PMU, which is a count of phrases related to risk and uncertainty related to the discussion of the economy during every FOMC meeting from 1987–2015. The PMU indices depict the intensity with which policymakers express uncertainty when discussing the economic situation. The authors complement these indices with topic-specific measures of directional language, reflecting policymakers’ views about the path of inflation, real economy, and financial markets. The inflation PMU is, in fact, strongly procyclical.
• They develop a new textual measure of policy stance based on the balance of hawkish and dovish language, namely the hawk-dove score, of the FOMC members in the policy round of the meeting. The hawk-dove score varies in an intuitive way and is a highly significant predictor of the federal funds rate (FFR) target.
• They estimate a version of a policy rule in which they allow uncertainty to affect the strength of the policy response to projected inflation and growth and find that uncertainty leads to an amplification of the policy response to fluctuations in economic forecasts.

Consistent with models of inflation scares, policymakers place weight on low probability but costly and therefore salient events, but those events do not realize in our sample. Our results highlight the central role of policymakers’ beliefs in understanding how deviations from policy rules occur. They also cast light on plausible mechanisms to be incorporated in models of optimal policy choice under uncertainty.

Policymakers’ Uncertainty
Authors: Anna Cieslak, Stephen Hansen, Michael McMahon, Song Xiao
From: Duke University, Imperial College, Oxford University, London School of Economics

The effects of macro uncertainty in the long-run

Very little attention, argue Carriero et al., has been paid to the impact of macro uncertainty on the economy in the long run. In order to explore the effects of macro uncertainty in the the long-run, they augment the results provided by Jurado et al. (2015) which develops measures of uncertainty based on a large set of macroeconomic and financial data and identifies uncertainty shocks through timing restrictions. The richer dynamics show that uncertainty shocks produce two waves of reduction in output:

The first has already been uncovered in many empirical contributions, and it reaches its trough within two years from the shock. The second contraction starts after approximately six to eight years from the shock and has not been uncovered before. This evidence is robust to several changes in the model’s specification and identification assumptions, and it is consistent with the “real option” hypothesis in which high uncertainty leads firms to postpone investments, thereby curbing the optimal allocation of resources that drives economic growth in the long run.

Macro Uncertainty in the Long Run
Authors: Andrea Carriero, Massimiliano Marcellino, Tommaso Tornese
From: Queen Mary University of London, Bocconi University