Measuring uncertainty, and its role in business cycles

by on October 4, 2013 at 1:47 pm in Economics | Permalink

That is a new paper by Kyle Jurado, Sydney C. Ludvigson, Serena Ng, here is the abstract:

This paper exploits a data rich environment to provide direct econometric estimates of time-varying macro uncertainty, defined as the common variation in the unforecastable component of a large number of economic indicators. Our estimates display significant independent variations from popular uncertainty proxies, suggesting that much of their variation is not driven by uncertainty. Quantitatively important uncertainty episodes appear far more infrequently than indicated by popular uncertainty proxies, but when they do occur, they have larger and more persistent correlations with real activity. Our estimates provide a benchmark to evaluate theories for which uncertainty shocks play a role in business cycles.

It is common these days to criticize “uncertainty theories” by tying them to Republican complaints about President Obama.  But in fact risk and uncertainty approaches to business cycles are increasingly popular, and they exist in much stronger forms than what you usually hear discussed.  There is an ungated version of the paper here (pdf)

david October 4, 2013 at 1:55 pm

I note that the paper analyses uncertainty through the divergence in forecasts; it does not mention any policies which are commonly alleged to increase ‘uncertainty’.

Ryan October 4, 2013 at 2:04 pm

It’s unfortunate that this literature developed partisan connotations in much of the blogosphere and journalism. It has led some to write it off as obviously wrong and others to apply it to events in unproductive ways, all for partisan reasons. I have always found it puzzling that Republicans see it as a vindication of their worldview and Democrats have wanted to ignore it, since it’s far from clear that the blame for the current climate of policy uncertainty rests with one party or one set of policy initiatives.

Z October 4, 2013 at 4:51 pm

The reason, I suspect, is that the entirety of the Left depends on [i]certainty[/i]. If some part of human relations are indeed a random walk, liberalism collapses. Therefore the Left has to attack the concept of randomness and the Right uses it as a battering ram.

Bernard Guerrero October 4, 2013 at 5:41 pm

Hmmnn. Couldn’t you argue the exact opposite? If, for instance, wealth or life outcomes are wholly or largely driven by chance, you can make an argument that leveling or redistributive policies are only fair, and non-distortionary. OTOH, to the extent that hard work, acquired skill or personal choice enters into the equation, it becomes more difficult to justify taking from one to give to a less-worthy other while providing negative incentives for trying harder than the next guy.

bmcburney October 4, 2013 at 6:23 pm

Aren’t you confusing uncertainty with chance? This is not a moral argument about whether people should be allowed to keep what they have. The political aspect of the argument is that change produces uncertainty and uncertainty has negative economic consequences. In general, the right opposes change in existing social and economic arrangments while the left demands it. To the extent uncertainty produces economic disappointment, sensible people will oppose “bold [and] persistent experimentation” because of the damage it does to living standards. The 1950s were a boring but productive decade, since then social and political arrangements have been subject to constant revision (which caused The Great Stagnation?).

david October 4, 2013 at 6:35 pm

But uncertainty in a planned heavily-nationalized economy might be very low. You might also all be poor, but you would have very few individual risks. And after a generation under planning, it is denationalization that would be change, whilst the left would be demanding a continuation of the status quo.

Z October 4, 2013 at 7:25 pm

I was not addressing any of those issues. The fundamental starting point of all left wing ideologies, all secular religions for that matter, is that things can be arranged in such a way to produce plenty, surplus, justice, equality, transformation of society, etc. These promised benefits are what justifies the use of force. Otherwise, leftist movements are just imposing their will on whoever they can dominate. That last bit is where the right comes into the picture. They dispute the premise. The reason the Catholic Church made immanentizing the eschaton a heresy is they rejected the notion that you could perfect the human condition. That and burning heretics was a good time in the old days.

Victor Wooten October 4, 2013 at 2:38 pm

Avoiding the phrase “I don’t have time…”, will soon help you to realize that you do have the time needed for just about anything you choose to accomplish in life.

Andrew' October 4, 2013 at 2:41 pm

Ending aging?

Victor Wooten October 4, 2013 at 3:52 pm

Our greatest glory is not in never falling, but in getting up every time we do.

TallDave October 4, 2013 at 5:01 pm

It’s funny what we think we know that we don’t. Yesterday we thought someone had successfully bought insurance through Obamacare. Today we find out he didn’t.

It’s also odd that anyone believes we understand climate well enough to predict what it will do within a few degrees for the next 100 years; was there ever any real evidence to support that notion? Advocates just leapt right past that stunning arrogance and made the even more audacious claim that we can say what it will do as a function of the concentration of certain greenhouse gasses. The empirical mind boggles!

Andrew' October 4, 2013 at 5:56 pm

Well, now that I realized the government can seize bitcoins I’m bullish.

bmcburney October 4, 2013 at 6:01 pm

Does it strike anyone else as odd that a certain form or type of economic analysis can be subject to criticism by the simple expedient of “tying them to Republican complaints about President Obama”?

And which element of that formula is dominant? Is the analysis shown to be false because Republicans use it or is it shown to be false because it is used to complain about President Obama?

mike October 4, 2013 at 7:05 pm

Yeah, it’s sort of like the controversy over heritability of intelligence. Leftists claim it is “discredited” because right-wing Nazi types believed in it, Dittoheads claim it is “discredited” because left-wing Progressive types believed in it. I mean, just by itself, isn’t the fact that people believed something, especially large numbers of people for a long time, usually evidence that it’s true? It’s not a perfect predictor, obviously, but it’s certainly a positive effect. It seems that in certain fields, the fact that virtually everybody believed X for thousands of years is treated as proof that X is untrue.

Ryan Vann October 4, 2013 at 7:19 pm

It’s a sensitive issue to even consider touching in a pluralistic society. I think the guilt by association defense is just a convenient way to avoid the discomfort.

bmcburney October 4, 2013 at 7:56 pm

Mike,

I agree that it should be possible to agree that intelligence is at least partly heritiable without endorsing the Holocaust. But even in those terms, it is one thing to say that an idea is discredited because in the past it was used by Nazis to justify the Holocaust or was used by Progressives to justify forced sterilizations, are “complaints about President Obama” really equivalent to those examples? Are Republicans really that similar to Nazis?

mike October 4, 2013 at 10:45 pm

B is bad implies that A is bad only if A implies B. So, for example, the badness of the Holocaust implies that heritability of intelligence is bad only if you believe that the heritability of intelligence really does mean we should incinerate the less intelligent.

Somehow we have arrived at a paradigm (See Martha Minow’s comments on the Stephanie Grace scandal) where it is morally virtuous to believe that if intelligence is hereditary then we should incinerate the less intelligent, and therefore intelligence MUST NOT be hereditary! Personally, I don’t think that we should incinerate anybody – regardless of whether intelligence is hereditary. But I believe based on the evidence that there is a strong hereditary component to intelligence, which makes me a bad person.

I guess what I’m saying is that I think the world would be a better place if we all just agreed that incinerating people is bad no matter what your reasons, so we can just try to figure out the truth about the way the world works without worrying that it will lead to genocide.

Ryan Vann October 4, 2013 at 7:07 pm

I suppose it is not really odd anymore in the standard definition of the word; guilt by association fallacies and variants have been around for a long time, and seem to be more pronounced and common-place in recent years, and especially on the internet.

Ryan Vann October 4, 2013 at 7:27 pm

“But uncertainty in a planned heavily-nationalized economy might be very low. You might also all be poor, but you would have very few individual risks. And after a generation under planning, it is denationalization that would be change, whilst the left would be demanding a continuation of the status quo. – See more at: http://marginalrevolution.com/marginalrevolution/2013/10/measuring-uncertainty.html#sthash.v6S88GpL.dpuf

Why would uncertainty decrease as power coalesces in one institution, person, etc? The relationship would appear unclear; does anyone have empirical evidence one way or the other? In one sense, if power is consolidated, policy is easy to dispense with and initiate. The question then becomes one of what view points then dominate policy making. If opinion makers are, and I would think this is the case, more schizophrenic, then uncertainty would seem to rule the day. If power brokers and opinion makers seem to be of a consensus and not subject to deviations, then certainty reigns.

Jody Neel October 4, 2013 at 7:48 pm

1) aggregate human behavior has a lot smoother response function than individual responses. E.g., peanut butter decreases in price – now what happens to the quantity purchased?

2) closely related, aggregate human behavior tends to be closer to homo economicus than individual behavior.

3) with centralized decision making, a single decision change has a dramatic impact. See for instance national park availability (but if a single individually managed park closes for a week, who cares?)

4) assume averaging of sorts in the aggregation. Then variance is inversely proportional to population size

5) if you have ever tried to launch a new product,
Consumer products are a lot easier to plan for than sales to the government – 1 person in a bad mood kills the sell to the government (and thus the product), but a single sale is inconsequential to the consumer product.

mulp October 5, 2013 at 12:53 am

As a scientist/engineer, I grew up with a concept of uncertainty, and on ways to understand and measure uncertainty and reduce uncertainty. They always require increasing the amount of measuring, the kinds of things measured, the ways to measure the same thing, and the frequency that these things are measured, and the number of people doing the measuring and the number of people analyzing the data and checking it for consistency with other data.

The IPCC just issued a meta analysis of the hundreds and thousands of recent reports on recent measurements, reporting on the things that are highly certain and the things that seem very uncertain and very confusing.

The latter will trigger new rounds of measurements and analysis which will be wrapped up in the next IPCC report in about five years.

Economists, on the other hand, dismiss the IPCC report as nonsense, and then turning to economics just write more political-economic theory papers that state that it is certain that Obama and the minimum wage and unions and liberals and environmentalists and taxes and spending are causing all the things that make people feel things aren’t going as well for them as it did for their parents.

Who needs measurements and data….

Andrew' October 5, 2013 at 1:33 pm

This is mostly about things that can’t be measured.

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