July 5, 2017
Research examines negative impact of economic policy uncertainty
WEST LAFAYETTE, Ind. — If there is one thing certain about U.S. policy in turbulent times, it is uncertainty. From health-care and tax reform to trade and the environment, the economic consequences of stalled policymaking have significant economic implications.
According to research by Huseyin Gulen, a professor of finance at Purdue’s Krannert School of Management, the impact on corporate investment is particularly negative, both from a short- and long-term perspective.
Gulen and his co-author, Mihai Ion of the University of Arizona, detail their findings in “Policy Uncertainty and Corporate Investment,” which was published as an Editor’s Choice lead article in The Review of Financial Studies. The researchers used the Economic Policy Uncertainty Index, which measures the occurrence in newspaper articles of words related to economic uncertainty and gauges the number of expiring tax laws and the spread among economic forecasts, to examine uncertainty following the 2008‑09 financial crisis.
Their findings document a strong negative relationship between capital investment and the aggregate level of uncertainty associated with future policy and regulatory outcomes.
“We also found important evidence that the link between policy uncertainty and capital investment is not uniform,” Gulen said. “It is significantly stronger for firms with a higher degree of investment irreversibility, as well as for firms that are more dependent on government spending. That lends empirical support to the conclusion that policy uncertainty can depress corporate investment and induce precautionary delays.”
Based on their data sample, the researchers estimate that doubling the level of policy uncertainty results in an average decrease in quarterly investment rates of some 8.7 percent.
“This is a sizable effect, especially considering that the policy uncertainty index nearly tripled during the recent financial crisis,” Gulen said. “Our analysis indicates that it may be accountable for almost one-third of 32 percent decline in capital investments during the period we studied.”
Even more troubling were the long-term implications.
“We found that policy uncertainty can affect investment levels up to eight quarters into the future,” Gulen said. “It seems to be progressively negative over the first four to five quarters. Once uncertainty is resolved, firms increase investments to satisfy pent up demand, but the fact that this rebound takes two to three years shows that it can take a significant amount of time to recover.”
What are the implications for the current and future U.S. economy? The data continues to gather, but despite historic gains in the stock market, the EPU Index following the election of President Donald Trump has remained higher than at any point during the 2008-09 financial crisis.
“Politics aside, regulators should be mindful of the fact that the uncertainty surrounding their decisions can be just as damaging as making the wrong decision,” Gulen says. “Corporations also should be aware that different firms will be affected to different degrees and that policy uncertainty can have long-lasting impacts.”
Writer: Eric Nelson, firstname.lastname@example.org
Source: Huseyin Gulen, email@example.com
Media contact: Howard Hewitt, firstname.lastname@example.org