Uncertain about uncertainty
By Scott Sumner
I’ve always been a bit skeptical when people point to “uncertainty” as the cause of economic distress. High unemployment? Uncertainty about ObamaCare! More often, the problem is bad monetary policy, and the only “uncertainty” is just how much NGDP instability the central bank will tolerate.
And yet I don’t want to be dogmatic, it seems plausible that uncertainty would create at least some distress, as investors held off on new projects. Even if the central bank maintained stable NGDP growth (as it should) there might be a decline in RGDP due to the sort of “re-allocation” that Arnold Kling often discusses.
The recent Brexit shock is by far the biggest uncertainty shock that I’ve ever seen hit a major economy (apart from monetary/uncertainty shocks, such as 2008). There are many reports that investment projects in the UK are being put on hold. So I’m going to keep an open mind, and revise my views as the data comes in.
In a recent post, I made the following comment (italics), and commenter Tom Brown responded with a question:
Not a definitive test (which would require observations with and without NGDP targeting, to tease out AD vs. AS channels), but certainly a suggestive test. I have an open mind at this point, and am eager to learn.
Can you describe which outcome(s) would most strongly suggest that your current beliefs are wrong? I’m not hoping that they are, I’m just wondering if we can somehow put a marker down now to compare with the future.
Here are three plausible outcomes:
1. Very little change in NGDP, and unemployment is fairly stable, rising by less than 100 basis points.
2. Very little change in NGDP, and unemployment rises sharply, as the UK slides into recession.
3. NGDP slows sharply, and unemployment rises sharply.
In cases #1 and #2, monetary policy stays neutral, and we get a test of the aggregate supply effects of reallocation. In that case, I think #1 is more likely. I’ll say the unemployment rate rises by 50 basis points within a year, if you want a point estimate to judge me by.
In case #3, we don’t really have a clean test. Nonetheless, I think those who disagree with me would be at least somewhat justified in claiming that uncertainty was really important, if only because central banks weren’t very good at offsetting it. So case #3 would not be a slam-dunk victory for those who disagree with me, but it would be a qualified win, and a modest loss for me. Case #2 would mean I was even further off base in my estimate of the impact of uncertainty.
PS. Just to reassure readers, I do not forget these tests. A few days ago I revisited a raging debate from a year ago, when the Chinese stock market crashed. Many said China faced a hard landing, whereas I predicted 6% growth. I also revisit other “tests”, such as Krugman’s famous 2013 test of market monetarism, or his 2014 test of ending extended unemployment benefits, or Tyler Cowen’s less famous observation that Denmark would provide a test of whether the Swiss actually had to devalue in early 2015 (we now know they did not.) Or pundit predictions that Bitcoin was a bubble. And many others. So have no fear, I’ll revisit this even if I am wrong, which is very possible.