Prime Minister Ishiba Shigeru has dissolved the House of Representatives for a general election. Of course, the outcome of the election on October 27 is uncertain. A presidential election is also approaching in the United States, and the two candidates’ approval ratings are very close, making it difficult to predict the outcome. Elections are the foundation of democracy. However, close elections and regime changes often increase policy uncertainty.
While uncertainty has long been an important research topic in economics, the global financial crisis accelerated research on the topic. It has been found that heightened uncertainty has negative impacts on corporate investments, employment, and household consumption. Some studies have shown a negative effect on birthrates. Leading impacts include a mechanism called “real option effect.” The real option theory is that since companies and households make economic decisions based on expectation for the future, heightened uncertainty about future economic growth, prices, and income leads companies and households to retain a wait-and-see attitude until uncertainty is resolved.
Unforeseen events, such as large-scale disasters, can increase uncertainty. The COVID-19 crisis was an uncertainty shock that made future events difficult to predict. On top of the direct negative effects of restrictions on economic activity, heightened uncertainty exerted additional impacts.
Many studies have shown that policy uncertainty also exerts downward pressure on economic activity. When the outlook for budgets, tax systems, legal reform, monetary policy, etc. are uncertain, companies and households affected by relevant policies refrain from taking decisive actions. As a result, the effectiveness of policy may diminish, or unintended side effects may arise. The government avoiding the creation of unnecessary uncertainty is itself therefore an important facet of economic policy.
In the United States, an economic policy uncertainty index based on text analysis of newspaper articles has been developed, and indices for many countries are now available. On the advice of economists who developed the index, RIETI Senior Fellow Arata Ito has created an index for Japan based on articles in major national newspapers. The global financial crisis and the COVID-19 crisis led to significant increases in uncertainty in both the Japanese and U.S. indices. The U.S. index remained high around the inauguration of the Trump administration in 2017. The Japanese index stayed high when successive cabinets were short-lived due partly to the divided parliament between 2007 and 2012. These examples indicate that government changes and unstable politics can become a source of policy uncertainty.
As Japan's economy has nearly escaped from its long deflationary period, labor shortages have become serious. Under these circumstances, raising the potential growth rate through improvements to productivity is naturally the main focus of economic policy. However, economic growth measures such as research and development, human capital investment, and regulatory reform will take time to produce effects. For this reason, they have less political appeal than short-term economic stimulus measures such as cash handouts and tax cuts.
In election campaigns, “support” is often used as a keyword that easily appeals to voters and candidates propose various support measures, ignoring sources of funding for those measures. However, Japanese government debt, which has ballooned further due to the COVID-19 crisis, is itself a potential source of uncertainty shocks. Increasing the predictability of future policies to dispel fears is important for inducing positive behavior from both companies and households.
>> Original text in Japanese
* Translated by RIETI.
October 11, 2024 - Published in Nihon Keizai Shimbun's "Economist 360° Perspective"
