Fluctuations in uncertainty
BibTeX
@article{bloom2014fluctuations,
title={Fluctuations in uncertainty},
author={Bloom, Nicholas},
journal={Journal of Economic Perspectives},
volume={28},
number={2},
pages={153--76},
year={2014}
}
Abstract
Uncertainty is an amorphous concept. It reflects uncertainty in the minds of consumers, managers, and policymakers about possible futures. It is also a broad concept, including uncertainty over the path of macro phenomena like GDP growth, micro phenomena like the growth rate of firms, and noneconomic events like war and climate change. In this essay, I address four questions about uncertainty. First, what are some facts and patterns about economic uncertainty? Both macro and micro uncertainty appear to rise sharply in recessions and fall in booms. Uncertainty also varies heavily across countries—developing countries appear to have about one-third more macro uncertainty than developed countries. Second, why does uncertainty vary during business cycles? Third, do fluctuations in uncertainty affect behavior? Fourth, has higher uncertainty worsened the Great Recession and slowed the recovery? Much of this discussion is based on research on uncertainty from the last five years, reflecting the recent growth of the literature.
My Notes
Frank Knight defined uncertainty
- Risk
- known prob dist over set of events. Fair coin flip is risky.
- Uncertainty
- Inability to forecast likelihoods. Number of coins in existence is uncertain.
Known unknowns and unknown unknowns essentially.
Article mixes the concepts.
Proxies for measuring uncertainty:
- volatitily of stock market
- volatility of GDP
- forecaster disagreement
- mentions of “uncertainty” on the news
- dispersion of productivity shocks
Facts of uncertainty
Macro Uncertainty rises in recessions
Measures of uncertaity like VIX index are countercyclical.
Partial explanations:
- leverage (firms taking on more debt)
- Only 10 percent explained by leverage (Schwert 1989)
- Options insure against price movements. Recessions increase prices of options.
- Flucutations in risk aversion too small to explain VIX fluc (Bekaert, Hoerova, and Lo Duca 2013)
- exchangerates and bond yields also more volatile
Counting “uncertainty: in newspapers or Beige book also countercyclical (persistant rise after 2008 though)
Micro Uncertainty rises in recessions
Per industry growth dispereses during recessions. Very striking. Top 1percent of industries spike up. Bottom 1 percent spike down.
Similar effects at firm level. Campbell, Lettau, Malkiel, and Xu (2001). 50% higher variation during recessions.
Sales growth rate lower on average and more spread out during recession. (Kehrig, 2011; Bloom, Floetotto, Jaimovich, Saporta-Eksten, and Terry 2012).
Price changes on specific products more volatile during recession. Vavra 2013
Wages and Income volatility countercyclical
Unemployment rises during recession.
Also wages for employed more volatile during recession. (Meghir and Pistaferri 2004; Storesletten, Telmer, and Yaron 2004; Heathcote, Perri, and Violante 2010)
Uncertainty Higher in Developing Countries
World Bank’s World Development Report 2014
- less diversified economies
- dependent on commodities with volatile prices like rubber, sugar, oil, coper
- more political shocks like coups, revolutions, wars
- more susceptible to epidemics and floods
- less effective monetary and fiscal stabilization policies
Cause of Uncertainty
Bad news
- JFK shot
- Cuban Missile crisis
- OPEX oil shocks
- 9 11
- Gulf Wars
Also Oct 82 bcycle good news increased uncertainty a wee bit?
Recessions cause it
- Good economy means more trading means more info aggregation
- Van Nieuwerburgh and Veldkamp 2006; Fajgelbaum, Schaal, and Tashereau-Dumouchel 2013
- More confidence when business as usual.
- Forecasting harder during recession because recessions are rare.
- Unclear or hyperactive policy increases uncertainty
- Recessions encourage policy makers to experiment
- More business slack frees up resources to try out new ideas and R+D
- Bachman and Moscarini 2011; D’Erasmo and Moscoso-Boedo 2011
- (Opposite of what I would expect TODO)
Effects of Uncertainty
Real Options
Uncertainty makes mistaken investment more likely. Increases value of waiting to develop.
Avoids Adjustment costs. Adjustment costs (loss when reselling capital) can be 50 percent of original value of capital.
Hiring adjustments (recruitment, trainting, severance) are 10-20 percent of wages. Also more search costs.
Only makes sense as a story if firm decisions are irreversible, not time constrained, and take place in imperfect market.
Similar story for decision to delay purchase of durable consumption goods (housing, cars, furniture). Makes consumers less sensitive to price signals.
Explains procyclical productivity: High uncertainty means productive firms expand less and low productivity firms shrink less. Both more cautious. Reallocation drives mojority of aggregate productivity growth. (Foster, Haltiwanger, and Krizan 2000, 2006)
Risk Aversion
Higher uncertainty leads to hgiher risk premia and default premia. Increases the cost of finance.
Ambiguity aversion: Agents can’t form prob dist. Instead act as if worst outcome will occur. As range of outcomes expands, worst outcome becomes worse. If agents are optimisitic instead and assume best outcome (CEOs?) uncertainty will lead to more investment instead.
More precautionary saving, means less consumption, which is bad in short run. Theoretically good in long run because more savings means more potential investment, but (Fernández-Villaverde, Guerrón-Quintana, Rubio-Ramirez, and Uribe (2011)) say most increased saving flows abroad instead.
In closed economy, savings = investment, right? But even then, new keynesian sticky prices prevent markets from clearing. TODO: read
- Leduc and Liu 2012;
- Basu and Bundick 2011;
- Fernández-Villaverde, Guerrón-Quintana, Kuester, and Rubio-Ramirez 2011
Especially problematic if stuck at zero lower bound.
Growth Options
Positive effect of uncertainty.
Increases upper bounds of gains. Relevant to long-term investments. If things go south, just cancel.
Dot com boom?
Oil price uncertainty increases oil extraction ventures.
Kraft, Schwartz, and Weiss (2013) say higher uncertainty increases stock price of R+D heavy firms.
Oi-Hartman-Abel Effects
Positive effect of uncertainty.
If profits are convex in demand or costs, then mean-preserving spread in demand or costs increases expected profits.
Depends on firms being able to easily expand or contract. So stronger in the long run.
Empirical Effects of Uncertainty.
Difficult to seperate cause and effect.
Literature is sugestive but not conclusive. Uncertainty seems to hurt short-run growth. Effects on long-run growth unknown.
Timing
Ramey and Ramey (1995). Showed seperation of trend and deviation might not work so well. More volatile deviations connected to lower growth rates.
Various studies connect events to high uncertainty
- crash of 1929 (consumption)
- portugal joining EU (investment)
- trade flows in 2008
Individual firms invest less coorelated with volatile stock prices and self-reported volatility in profit forecasts.
Structural
Bloom et al (2012) builds equil model with unceratinty. Predicts firms pause hiring and investment during first year of recession. But sensitive to assumptions and parameters. Bachmann and Bayer (2012, 2013).
Natural Experiments
Disasters, terriorist attacks, political shocks as instruments. Baker,Bloom 2013 argues these shocks explain half of the variation in growth.
Stein, Stone 2012 uses exposure of firms to energy and currency volatility as instrument. More exposed firms have lower investment, hiring, advertising. Accounts for third of fall 2088-2010. But increases R+D spending.
Effect on Great Recession recovery.
Lots of policy makers blaim uncertainty.
Econometric evidence is iffy. Maybe caused about a third of the problem?
For example, quantitative easing has been used heavily by US monetary authorities to try and stabilize demand, but is clearly different from the recent history of interest rate manipulation. If public policy was communicated more transparently, would this act to reduce uncertainty, or would it introduce greater volatility by generating more frequent jumps in fi nancial markets after each policy pronouncement? The Federal Reserve is grappling with these questions as it seeks to be more transparent in signaling the path of monetary policy.