The global economy is now projected to grow at 3.3% in 2019, down from 3.6% in 2018, according to the April 2019 edition of the IMF’s World Economic Outlook (IMF 2019). The IMF points out several developments that have prompted the downward revision of the global economy. This includes the escalation of US–China trade tensions, the need for credit tightening in China, economic stress in countries such as Argentina and Turkey, and disruptions to the auto sector in Germany caused by the introduction of new emissions standards. Behind all the different reasons for the downward revision of global growth, there is one thing in common: rising uncertainty. Chapter 1 of the World Economic Outlook – which focuses on the prospects and policies for the global economy – mentions the word
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The global economy is now projected to grow at 3.3% in 2019, down from 3.6% in 2018, according to the April 2019 edition of the IMF’s World Economic Outlook (IMF 2019). The IMF points out several developments that have prompted the downward revision of the global economy. This includes the escalation of US–China trade tensions, the need for credit tightening in China, economic stress in countries such as Argentina and Turkey, and disruptions to the auto sector in Germany caused by the introduction of new emissions standards.
Behind all the different reasons for the downward revision of global growth, there is one thing in common: rising uncertainty. Chapter 1 of the World Economic Outlook – which focuses on the prospects and policies for the global economy – mentions the word “uncertain” and its variants 36 times. Some of the references discuss the impact of uncertainty on global economic growth. For instance, the report notes that “amid high policy uncertainty and weakening prospects for global demand, industrial production decelerated… The slowdown was broad based, notably across advanced economies”. The report also points out that political uncertainties “add downside risk to global investment and growth. These include policy uncertainty about the agenda of new administrations or surrounding elections, geo-political conflict in the Middle East, and tensions in east Asia”. On the impact of uncertainty and trade tensions, the report notes that “higher trade policy uncertainty and concerns of escalation and retaliation would reduce business investment, disrupt supply chains, and slow productivity growth”.
Similarly, the IMF’s report also discusses the impact of uncertainty on economic growth for specific countries. For instance, the report points out that a downward revision for growth in the UK partly reflects the “negative effect of prolonged uncertainty about the Brexit outcome”. And for South Africa, the downward revision for growth reflects “continued policy uncertainty”.
Rising uncertainty – here, there, and everywhere
These references are line with the latest reading of the World Uncertainty Index (WUI). The WUI’s latest data shows a sharp increase in global uncertainty in the first quarter of 2019 (Figure 1).
Figure 1 World Uncertainty Index (1996Q1 to 2019Q1, GDP weighted average)
Note: The World Uncertainty Index (WUI) is computed by counting the frequency of uncertain (or the variant) in Economist Intelligence Unit country reports. The WUI is then normalized by total number of words and rescaled by multiplying by 1,000. The WUI is then normalized by total number of words, rescaled by multiplying by 1,000, and using the average of 1996Q1 to 2010Q4 such that 1996Q1-2010Q4=100.A higher number means higher uncertainty and vice versa.
Uncertainty is rising in many parts of the world – in advanced, emerging, and low-income countries alike (Figure 2). Examples include uncertainty in Ireland regarding the outcome of Brexit, in Gabon related to President Ali Bongo Ondimba being admitted to the hospital after reportedly suffering a stroke, in South Africa around key policies, especially land reform, and in the Democratic Republic of Congo regarding the recent elections.
Figure 2 Uncertainty in Democratic Republic of Congo, Gabon, Ireland, and South Africa (World Uncertainty Index 1996Q3 to 2019Q1)
Implications of higher uncertainty
Higher uncertainty matters because it has serious consequences for the economy. For instance, in times of high uncertainty, companies may reduce investment and delay projects (Bloom et al. 2018, Dixit and Pindyck 1994). They do this because it is costly to reverse investment. So, they prefer to ‘wait and see’. Similarly, households reduce consumption as they wait for less uncertain times (Carrol 1997). Rising uncertainty also affects all sectors of the economy. It can increase the cost of credit to households and firms (Kelly et al. 2014, Gilchrist et al. 2010).
In our work, we find that increases in uncertainty foreshadow significant output declines. Based on our estimate, the increase in uncertainty observed in the first quarter could be enough to knock up to 0.5% of global growth over the course of the year. This average effect, however, masks significant heterogeneity within and across countries. Within countries, we find larger effects for sectors with higher financial constraints. Across countries, the effect is estimated to be larger and more persistent in countries with lower institutional quality (Figure 3).
Figure 3 GDP response to WUI innovations – local projection, the role of institutions
Panel A. Countries with below-median rule of law
Panel B. Countries with above-median rule of law
Note: Response estimated using the local projection method (Jorda 2005):
where y is the log of output; αi are country-fixed effects; γt are time-fixed effects; D is a dummy variable which takes value 1 for countries with a score in the indicator of rule of law (WB) below median; X is a set of controls including lags of the growth rate of output and of the WUI index. Estimates based on annual data for a panel of 143 countries from 1996 to 2017. Solid line denoted the impulse responses of GDP to a one-standard deviation increase in the WUI—equal to the change in average value in the index from 2014 to 2016. Dotted lines denote 90% confidence bands. The x-axis denotes year after the increase in the WUI.
Ahir, H, N Bloom, and D Furceri (2018), “World Uncertainty Index”, Stanford, mimeo.
Baker, S, and N Bloom (2013), “Does Uncertainty Reduce Growth? Using Disasters as a Natural Experiment,” NBER Working Paper no. 19475.
Baker, S R, N Bloom, and S J Davis (2016), “Measuring Economic Policy Uncertainty”, Quarterly Journal of Economics 131(4): 1593-1636.
Bloom, N (2009), “The Impact of Uncertainty Shocks,” Econometrica 77(3): 623-85.
Bloom, N, M Floetotto, N Jaimovich, I Saporta-Eksten, and S Terry (2018), “Really Uncertain Business Cycles,” Econometrica 86(3): 1031-1065.
Bloom, N, C Scarlet, and P Mizen (2019), “Rising Brexit uncertainty has reduced investment and employment”, VoxEU.org.
Carroll, C (1997), “Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis”, Quarterly Journal of Economics 112(1): 1-55.
Dixit, A and R Pindyck (1994), Investment under uncertainty, Princeton University Press.
Gilchrist, S, J Sim, and E Zakrajsek (2010), “Uncertainty, financial frictions, and investment dynamics”, Meeting Papers no. 1285, Society for Economic Dynamics.
Haddow, A, C Hare, J Hooley, and T Shakir (2013), “A new age of uncertainty? Measuring its effect on the UK economy”, VoxEU.org.
International Monetary Fund (2019), World Economic Outlook, April 2019, IMF.
Kelly, B, L Pastor, and P Veronesi (2014), “The price of political uncertainty”, VoxEU.org.