Policy Uncertainty and Economic Activity

Author Name ITO Arata (Fellow, RIETI)
Creation Date/NO. March 2016 16-J-016
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This paper empirically examines the macroeconomic effect of policy uncertainty. Policy uncertainty derives partly from uncertainty about the outcomes of government decision-making processes. I use the data on approval ratings by political party in opinion polls that are conducted monthly by the Japanese news media to develop a new index of political uncertainty. A newly constructed index spikes at some historically significant events including the incidence of the "twisted" Diet under which the majority differs in both houses. The index also has a strong positive correlation with some measures for the instability of steering the Diet proceedings by the ruling party (or parties), including the passage rate of Cabinet bills. The index shows similar movements to the newspaper-based policy uncertainty index for some parts of the period from 1989-2015 but fluctuates quite differently for other parts. With the new index as a proxy for movements in policy uncertainty over time, I employ a simple standard vector autoregression framework to estimate the dynamic relationship between policy uncertainty and economic activity. The results show that positive innovations in the index produce significant and persistent declines in the overall economic activity and that the negative effects are large on investment, durable consumption, and part-time employment.