If you believe "policy uncertainty” has been holding back the economic recovery, great news! Today’s jobs report might support your case. But maybe not in a way that many uncertainty theory proponents will like.
It appears that the year-end deal to avoid the fiscal cliff – tax increases and all – may have injected a healthy dose of certainty in the economy.
The uncertainty argument goes like this: Questions about what federal tax rates are going to be, or what regulations are going to look like, or how much the government is going to spend, nag so much at businesses that they put a chill on investment and hiring. This was a central tenant of Mitt Romney’s presidential campaign, and it’s a refrain you still hear from many business leaders and members of Congress.
There’s not a lot of empirical evidence supporting the theory. The best data we have come from a trio of economists at the University of Chicago and Stanford, who have constructed an index meant to measure the amount of policy uncertainty running through the economy. (Check out the index for yourself here. Mike Konczal raises questions about it here.)
The monthly index spiked in December as the fiscal cliff approached. Then it fell in January. In February, when the economy created 236,000 jobs, the index hit its lowest level since the end of 2009 other than a brief window in 2011.
Congress resolved the fiscal cliff and let the sequester take effect, apparently.
“A lot of the uncertainty we’d seen over the last two years was driven by two of the things that just happened” – the tax cuts that were set to expire at the end of last year, and the question of whether deficit reduction would begin in earnest – said Scott Baker, an economics grad student at Stanford who is one of the three creators of the uncertainty index.
His Stanford colleague, economics professor Nicholas Bloom, went further in an e-mail.
“I think the passing of the sequester without incident has led many to believe policy is less uncertain then believed,” he wrote. “It is the classic cry-wolf parable — if you shout fire many times and nothing happens, people start to ignore you. The same appears to be true with Washington — all the shouting and arguing over policy came and went and policy seems about as stable as before.
“So the perceived unpredictability of policy may now be passing, with firms getting back to hiring and investment. My guess is this is the turning point of the five-year era of roller-coaster policy, with growth finally restarting.”
Last summer I asked one of Romney’s top advisers, John Taylor, who is also a Stanford economist, which would be worse: uncertainty with a chance of lower taxes or the certainty of locked-in higher tax rates. He said higher rates would be worse.
His colleagues’ index seems to disagree. The next few months of economic data should help sort out the question.
Correction: An earlier version of this story had an incorrect byline.