Abstract
How does uncertainty about economic policy translate into uncertainty about macroeconomic outcomes, in particular inflation? New measures of consumer inflation uncertainty are compared to the economic and monetary policy uncertainty indices of [Baker, S., N. Bloom, and S. Davis. 2016. “Measuring Economic Policy Uncertainty.” Quarterly Journal of Economics.]. Economic policy uncertainty is more strongly correlated with uncertainty about shorter-run inflation than with uncertainty about longer-run inflation, while monetary policy uncertainty is more correlated with uncertainty about longer-run than shorter-run inflation. Both economic and monetary policy uncertainty Granger cause inflation uncertainty. Consumer inflation uncertainty can be computed for demographic subgroups. High income and high education consumers have the lowest inflation uncertainty, but their short-run inflation uncertainty is most strongly correlated with policy uncertainty. The long-run inflation uncertainty of the top income quintile is less correlated with policy uncertainty, possibly reflecting stronger anchoring of inflation expectations for this group. Policy uncertainty appears to reflect the expectations of consumers more than professional forecasters or financial markets.
Appendix A
Tables and Figures
Coefficient of variation and autocorrelation for uncertainty indices.
| Variable | Coef. of variation | Autocorrelation |
|---|---|---|
| EPU | 41.6 | 0.76 |
| MPU | 61.8 | 0.60 |
| Short-horizon CIU | 23.2 | 0.87 |
| Long-horizon CIU | 17.7 | 0.71 |
| CF inflation dispersion | 29.3 | 0.76 |
| Inflation risk premium | 13.8 | 0.72 |
Monthly data beginning in 1985. Economic and monetary policy uncertainty indices from Baker, Bloom, and Davis (2016). Consumer inflation uncertainty indices updated from Binder (2017). Consensus Forecasts inflation dispersion from Wright (2011). Inflation risk premium from Haubrich, Pennacchi, and Ritchken (2011) and the Federal Reserve Bank of Cleveland.
Granger causality tests from bivariate VARs of uncertainty indices.
| Response | |||||
|---|---|---|---|---|---|
| EPU | MPU | Short-run CIU | Long-run CIU | ||
| Impulse | EPU | – | 3 | 36.8*** | 14.2*** |
| MPU | 5.2 | – | 24.3*** | 17.8*** | |
| Short-run CIU | 5.1 | 3.4 | – | 11.8*** | |
| Long-run CIU | 16.1*** | 16.0*** | 4.1 | – | |
Table shows χ2 statistic from Granger causality Wald test that the row variable Granger causes the column variable. Each test follows a bivariate VAR with three lags of row and column variable. ***Denotes row variable Granger causes column variable with p < 0.01.
Granger causality test from bivariate VARs of first-differenced uncertainty indices.
| Response | |||||
|---|---|---|---|---|---|
| EPU | MPU | Short-run CIU | Long-run CIU | ||
| Impulse | EPU | – | 1.1 | 38.0*** | 9.2** |
| MPU | 3.4 | – | 18.1*** | 7.5** | |
| Short-run CIU | 0.7 | 2.6 | – | 7.2* | |
| Long-run CIU | 6.8* | 3.6 | 2.9 | – | |
Table shows χ2 statistic from Granger causality Wald test that the row variable Granger causes the column variable. Each test follows a bivariate VAR with three lags of row and column variable, first-differenced. ***denotes row variable Granger causes column variable with p < 0.01, **with p < 0.05, *with p < 0.1.
Orthogonalized impulse response functions.
Notes: Recursive VAR with the Cholesky ordering inflation (pi), unemployment (unemp), Economic Policy Uncertainty (EPU), short-horizon consumer inflation uncertainty (CIU_s), long-horizon consumer inflation uncertainty (CIU_l). Three lags of each variable and 303 monthly observations.
Orthogonalized impulse response functions.
Notes: Recursive VAR with the Cholesky ordering inflation (pi), unemployment (unemp), Monetary Policy Uncertainty (MPU), short-horizon consumer inflation uncertainty (CIU_s), long-horizon consumer inflation uncertainty (CIU_l). Three lags of each variable and 303 monthly observations.
Forecast error variance decomposition for multivariate VARs.
| Response | |||||
|---|---|---|---|---|---|
| EPU | Short CIU | Long CIU | Inflation | Unemp. | |
| a. VAR with EPU, CIU, inflation, and unemployment | |||||
| Impulse | |||||
| EPU | 0.77 | 0.14 | 0.07 | 0.03 | 0.12 |
| Short-run CIU | 0.03 | 0.75 | 0.29 | 0.01 | 0.23 |
| Long-run CIU | 0.05 | 0.01 | 0.48 | 0.05 | 0.01 |
| Inflation | 0.09 | 0.04 | 0.14 | 0.90 | 0.02 |
| Unemployment | 0.06 | 0.07 | 0.01 | 0.01 | 0.63 |
| Response | |||||
| MPU | Short CIU | Long CIU | Inflation | Unemp. | |
| b. VAR with MPU, CIU, inflation, and unemployment | |||||
| Impulse | |||||
| MPU | 0.85 | 0.13 | 0.07 | 0.01 | 0.05 |
| Short-run CIU | 0.02 | 0.74 | 0.29 | 0.01 | 0.25 |
| Long-run CIU | 0.05 | 0.01 | 0.49 | 0.05 | 0.01 |
| Inflation | 0.06 | 0.03 | 0.13 | 0.92 | 0.02 |
| Unemployment | 0.02 | 0.09 | 0.02 | 0.01 | 0.68 |
Table shows the fraction of variance in the response variable explained by the impulse variable at the 12-month forecast horizon.
Chi squared statistic for test that EPU or MPU Granger causes inflation uncertainty, by income quintile.
| Short horizon | Long horizon | |||
|---|---|---|---|---|
| Quintile | EPU | MPU | EPU | MPU |
| 1 | 8.8** | 6.0 | 4.8 | 8.7** |
| 2 | 25.3*** | 23.5*** | 17.4*** | 15.8*** |
| 3 | 26.9*** | 24.7*** | 13.2*** | 15.4*** |
| 4 | 31.6*** | 31.6*** | 17.7*** | 19.3*** |
| 5 | 31.1*** | 20.0*** | 9.3** | 9.1** |
Table shows χ2 statistic from Granger causality Wald test that EPU or MPU Granger causes inflation uncertainty by income quintile and horizon. Each test follows a bivariate VAR with three lags of row and column variable. ***p < 0.01, **p < 0.05, *p < 0.1.
Chi squared statistic for test that inflation uncertainty Granger causes EPU or MPU, by income quintile.
| Horizon 1 | Horizon 5 | |||
|---|---|---|---|---|
| Income quintile | EPU | MPU | EPU | MPU |
| 1 | 2.5 | 3.4 | 4.6 | 9.4** |
| 2 | 4.2 | 4.0 | 16.1*** | 22.0*** |
| 3 | 5.3 | 2.7 | 3.7 | 5.5 |
| 4 | 6.2 | 2.3 | 11.2** | 9.6** |
| 5 | 7.5* | 8.7** | 14.5*** | 12.5** |
Table shows χ2 statistic from Granger causality Wald test that inflation uncertainty Granger causes EPU or MPU by income quintile and horizon. Each test follows a bivariate VAR with three lags of row and column variable. ***p < 0.01, **p < 0.05, *p < 0.1.
Policy uncertainty regressed on consumer and professional forecaster inflation uncertainty.
| (1) | (2) | (3) | (4) | |
|---|---|---|---|---|
| EPU | MPU | EPU | MPU | |
| SPF Uncertainty(t) | −0.06 | −0.06 | −0.23 | −0.31 |
| (−0.26) | (−0.25) | (−0.88) | (−1.04) | |
| SPF Uncertainty(t−1) | 0.28 | 0.16 | 0.01 | −0.20 |
| (1.45) | (0.71) | (0.03) | (−0.63) | |
| Unemployment | 0.42 | −0.22 | 0.29 | −0.43 |
| (1.41) | (−0.62) | (0.87) | (−1.12) | |
| Inflation | −0.68 | −0.10 | −0.07 | 0.62 |
| (−1.13) | (−0.14) | (−0.09) | (0.64) | |
| Squared Inflation | 0.63 | 0.32 | 0.23 | −0.16 |
| (1.04) | (0.44) | (0.32) | (−0.20) | |
| Fed Funds Rate | −0.36 | −0.59 | −0.44 | −0.66 |
| (−0.83) | (−1.15) | (−0.95) | (−1.22) | |
| Δ Fed Funds Rate | −0.44* | −0.51* | −0.27 | −0.30 |
| (−1.97) | (−1.92) | (−0.95) | (−0.94) | |
| t | −0.53* | −0.60 | −0.44 | −0.47 |
| (−1.81) | (−1.74) | (−1.44) | (−1.35) | |
| CIU Short(t) | 0.55 | 0.71 | ||
| (1.27) | (1.41) | |||
| CIU Short(t−1) | −0.12 | −0.06 | ||
| (−0.32) | (−0.14) | |||
| Observations | 23 | 23 | 23 | 23 |
| R2 | 0.560 | 0.385 | 0.617 | 0.492 |
*p < 0.10, **p < 0.05, ***p < 0.01. Standardized beta coefficients; t statistics in parentheses.
Uncertainty and professional forecaster dispersion.
Notes: All series have been normalized by subtracting the mean and dividing by the standard deviation. The consumer inflation uncertainty index at the 1-year horizon is constructed according to the methodology in Binder (2017). The policy uncertainty index data from Baker, Bloom, and Davis (2016) was downloaded at www.policyuncertainty.com. Professional forecaster dispersion is the standard deviation of forecasts from Consensus Forecasters, downloadable in the replication files for Wright (2011) .
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