Monday, March 21, 2011

Uncertainty Shock

This is another interesting view by US economists at Goldman Sachs:

Uncertainty can cause firms or individuals to postpone irreversible big-ticket purchases or investments. The option value of waiting to get a better read on the future goes up in uncertain times, leading to “wait and see” behavior that results in a short-term decline in economic activity. Once the coast is clear, activity typically rebounds (exhibit below right). The impact of “uncertainty shocks” can therefore look quite different than the impact from forces such as monetary tightening.

Our own tests, following in the spirit of recent academic research on the topic, find that “uncertainty shocks” have a fast-acting, negative impact on growth, but rarely lead to recession. As expected, the effect is clearest for “big ticket” purchases or investments. A large part of the impact on the economy appears to occur via subsequent changes in financial conditions, reaffirming the usefulness of a financial conditions framework for forecasting in uncertain times.

Click on chart to enlarge, courtesy of Goldman Sachs.

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