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Uncertainty weighing on the global recovery

Bouts of elevated uncertainty have been one of the defining features of the sluggish recovery from the global financial crisis. This column explores the role of uncertainty in driving macroeconomic outcomes using data from a large group of advanced countries over the past 40 years. It concludes that uncertainty appears to hinder growth.

In recent months, high uncertainty has again coincided with weakness in the global recovery. Many commentators argue that there is a causal link between the high uncertainty and weak recovery (Bloom 2011). Uncertainty is associated with escalating financial stress and recession in the Eurozone, stalling labour markets in the US, and slowing growth in emerging market and developing economies. In this column, we draw on our recent work to explore the role of uncertainty in driving macroeconomic outcomes (see Box 1.3 in IMF 2012). Two major questions are addressed:

  • How has uncertainty evolved over time?
  • How does it affect growth and business cycles?
How has uncertainty evolved over time?

Economic uncertainty refers to an environment in which little or nothing is known about the future state of the economy. There is a great variety of sources of economic uncertainty, including changes in economic and financial policies, dispersion in future growth prospects, productivity movements, wars, acts of terrorism, and natural disasters (Bloom 2009). Because of its latent nature, uncertainty is difficult to quantify and has been measured indirectly in a number of ways.

We use four measures of macroeconomic uncertainty in our study. The first is the monthly standard deviation of daily stock returns in each of the 21 advanced OECD countries in our sample. The second is the Chicago Board Options Exchange Volatility Index (VXO), which is an indicator of the implied volatility of equity prices calculated from S&P 100 options. The third refers to uncertainty surrounding economic policies (for different measures of uncertainty, see Baker, Bloom, and Davis 2012). The last one, which represents uncertainty at the global level, is the estimated dynamic common factor of the first measure using the series of the six major advanced economies with the longest available data.

Both macroeconomic and policy measures of uncertainty tend to rise during global recessions (Figure 1). Policy uncertainty in the US and the Eurozone has remained high since the global financial crisis and the recent sovereign-debt problems in the Eurozone. Moreover, during the lethargic global recovery, uncertainty has been unusually high and volatile. This contrasts with the recoveries following the other three global recessions, which were accompanied by steady declines in uncertainty.

Figure 1. Evolution of uncertainty

Note: In figures 1a and 1b, shaded areas denote periods of global recession. The four global recessions (in 1975, 1982, 1991, 2009) are identified following Kose, Loungani, and Terrones (2009). In panel 2, economic policy uncertainty in the US and the Eurozone is from Baker, Bloom, and Davis (2012). In panel 3, each line presents the evolution of uncertainty in the US starting three quarters after uncertainty reached its peak during the respective global recession.

Sources: IMF staff calculations and Baker, Bloom, and Davis (2012).

Uncertainty is highly countercyclical at a national level. Macroeconomic uncertainty varies over different phases of the business cycle – during expansions, uncertainty is, on average, much lower than during recessions, regardless of the measure we use (Figure 2).

Figure 2. Uncertainty over the business cycle

Notes: Each bar represent mean uncertainty over the recession and expansion phases of the business cycle (see Claessens, Kose and Terrones, 2012). Country-specific uncertainty refers to the monthly standard deviation of daily stock returns in each country. Global uncertainty can be negative since it is demeaned. *** denote that the means are statistically significantly different from each other at 1% level.

Source: IMF staff calculations.

How does uncertainty affect growth and business cycles?

Economic theory suggests that macroeconomic uncertainty can have an adverse impact on output through a variety of channels. On the demand side, for example, when faced with high uncertainty firms reduce investment demand and delay their projects as they gather new information (as investment is often costly to reverse). On the supply side, firms’ hiring plans are also negatively affected by higher uncertainty reflecting costly adjustment of personnel.

Empirical evidence suggests that uncertainty tends to be detrimental to economic growth. The growth rate of output is negatively correlated with macroeconomic uncertainty. Our empirical analysis indicates that one standard deviation increase in uncertainty is associated with a decline in output growth of between 0.4 and 1.25 percentage points depending on the measure of macroeconomic uncertainty (for details see Kose and Terrones 2012). Policy-induced uncertainty is also negatively associated with growth. As noted, policy uncertainty has increased to record levels since the Great Recession. Specifically, the increase in policy uncertainty between 2006 and 2011 was about five standard deviations. This sharp increase in policy uncertainty may have stymied growth in advanced economies by 2 and a half percentage points during this period (these findings are consistent with those reported in recent studies, see Bloom 2009, Baker and Bloom 2011, Hirata and others 2012, Bloom and others 2012, and Baker, Bloom, and Davis2012).

The degree of economic uncertainty also appears to be related to the depth of recessions and strength of recoveries. In particular, recessions accompanied by high uncertainty are often deeper than other recessions (Figure 3). Similarly, recoveries coinciding with periods of elevated uncertainty are weaker than other recoveries. The unusually high levels of uncertainty the global economy experienced since the 2007-2009 financial crisis and the associated episodes of deep recessions and weak recoveries play an important role in explaining these findings.

Figure 3. Uncertainty and business cycles

Notes: A recession is associated with high uncertainty if the level of uncertainty falls in the top quartile of uncertainty measured at the troughs of all recessions. A recovery is associated with high uncertainty if the level of uncertainty during the recovery is in the top quartile of the average uncertainty of all recovery episodes. The periods of recession and recovery are defined following Claessens, Kose and Terrones (2012). All statistics correspond to sample median. ** and * denote that features of recessions (recoveries) with high uncertainty differ significantly from those of other recessions (recoveries) at the 5% and 10% levels, respectively.

Source: IMF staff calculations.

Global Recovery in Times of Manifold Uncertainty

Elevated uncertainty historically coincides with periods of lower growth, and the recent pickup in uncertainty raises the spectre of another global recession. Policymakers can do little to alleviate the intrinsic uncertainty economies typically face over the business cycle. However, policy uncertainty is unusually high, and it contributes significantly to macroeconomic uncertainty. By implementing bold and timely measures, policymakers can reduce policy-induced uncertainty and help kick-start economic growth.

Editors' Note: This column is based on a more detailed analysis of the impact of uncertainty on activity presented in Box 1.3 of the IMF’s latest World Economic Outlook. The views expressed in this article are those of the author(s) and do not necessarily represent those of the IMF or IMF policy.


Baker, Scott and Nicholas Bloom (2011), “Does Uncertainty Drive Business Cycles? Using Disasters as a Natural Experiment”, Working Paper, Stanford University.

Baker, Scott and Nicholas Bloom (2012), “Falling policy uncertainty is igniting the US recovery”, VoxEU.org, 7 February.

Baker, Scott, Nicholas Bloom and Steven J Davis (2012), “Measuring Economic Policy Uncertainty”, Working Paper, Stanford University.

Baker, Scott, Nicholas Bloom and Steven J Davis (2012), “The Rocky Balboa Recovery”, VoxEU.org, 20 June.

Bloom, Nicholas (2009), “The Impact of Uncertainty Shocks”, Econometrica, 77(3): 623-685.

Bloom, Nicholas (2011), “The uncertainty shock from the debt disaster will cause a double-dip recession”, VoxEU.org, 22 August.

Bloom, Nicholas, Max Floetotto, Nir Jaimovich, Itay Saporta-Eksten and Stephen Terry (2012), “Really Uncertain Business Cycles”, NBER Working Paper No. 18245.

Claessens, Stijn, M Ayhan Kose and Marco E Terrones (2012), “How do Business and Financial Cycles Interact?”, Journal of International Economics, 87(1):178-190.

Hirata, Hideaki, M Ayhan Kose, Christopher Otrok and Marco Terrones (2012), “Global House Price Fluctuations”, NBER Working Paper,18362.

IMF (2012), “Coping with high debt and sluggish growth”, World Economic Outlook, Washington DC.

Kose, M Ayhan and Marco Terrones (2012), “How Does Uncertainty Affect Economic Performance?”, Box 1.3, World Economic Outlook, October, 49-53.

Kose, M Ayhan, Prakash Loungani and Marco Terrones (2009), “Out of the Ballpark: The Global Recession of 2007-08 in Historical Context”, Finance & Development, June, 25-28.

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