Optimism is again swirling that the economy is finally, finally, finally set to break out of its recovery doldrums and into a year – next year, but still! – of strongish growth. You’d be forgiven for not buying it yet. We’ve heard this fast-growth-is-right-around-the-corner song before, and there’s a decent case that it won’t end any differently this time around.
But you should know that something is different this year, and, depending on your economic philosophy, it could be a pretty big something. You can call it “certainty,” or you can call it “confidence.”
Either way, it’s surging.
Conservative lawmakers and economists have contended, almost since the official end of the recession in mid-2009, that policy uncertainty was holding back growth. Mitt Romney, House Speaker John Boehner, a host of economists – they all promised that if Washington lifted the cloud of uncertainty hanging over American businesses, those businesses would grow confident in the future and invest and hire in droves.
This is the belief that liberal economist Paul Krugman derisively dubbed “the confidence fairy.” It’s a persistent one among Republican lawmakers and business leaders of all stripes: The Federal Reserve’s Beige Book, which tracks economic activity through surveys of businesses across the country, cited “uncertainty” 15 times in April and 22 times in March. (The Fed releases its next Beige Book report this afternoon.)
One confusing thing about the uncertainty argument, though, is that it can mean so many different things. Businesses could be feeling uncertain about potential tax changes, or possible new government regulations or a bond-market meltdown caused by exploding federal budget deficits. They could simply be uncertain about whether the recovery is durable and whether more customers are about to flow their way. So, there are a lot of possible sources of uncertainty, and, to borrow Krugman’s phrase, a lot of confidence fairies who might sprinkle growth across the economy if those uncertainties are resolved.
What if all those confidence effects arrived at the same time? We’d presumably see a boom in investment and job creation, right?
We’re in the midst of finding out.
The semi-secret of the last five months is that, by several measures, uncertainty is plunging and confidence is rising. Here’s the first: the Economic Policy Uncertainty Index built by Stanford and University of Chicago economists, which is as close as we’ve got to actual quantification of uncertainty effects in the economy.
Look how fast it has fallen since January, to nearly its lowest level in three years. That’s because the fiscal cliff deal ended years of will-these-rates-expire questions about tax policy, and also because financial threats from Europe appear to be receding, according to Stanford’s Scott Ross Baker, one of the researchers who compiles the index.
At the same time, consumer confidence is up to pre-recession levels.
The budget deficit is shrinking, and the growth of government spending on health care has slowed. And you know what stock market optimism looks like right now.
A few big uncertainties remain, including how businesses will react to the implementation of the Affordable Care Act and when the Fed will begin tightening monetary policy. Still, the certainty/confidence story appears to have shifted.
“The perceived unpredictability of policy may now be passing, with firms getting back to hiring and investment," Stanford economist Nicholas Bloom, one of the uncertainty index researchers, told me in March, when the index began to drop. "My guess is this is the turning point of the five-year era of roller-coaster policy, with growth finally restarting.”
Alberto Alesina, the Harvard economist whose work is the backbone of the so-called expansionary austerity doctrine -- built around the idea that budget cuts unleash confidence and growth -- expressed similar optimism. Since my interviews with both men, the uncertainty situation has only improved.
Now that so many of the confidence metrics are pointing up, we should find out whether those predictions are correct or whether the economy will remain bogged down by spending cuts and tax increases, the hallmarks of a fiscal policy that Krugman and other Keynesian economists have insisted were the problem all along.