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A precise measure of uncertainty? : The Economic Policy Uncertainty Index tries to quantify unpredictability

Summary:
[embedded content] FREDcast, FRED’s forecasting game, asks players to forecast four major macroeconomic variables by the 20th of every month. Some players may be frustrated by the erratic behavior of some of these indicators as they attempt to make their guesses. Fair enough. Plenty of other data analysts are in the same boat. Well, a team of researchers has been trying to quantify this sense of uncertainty using the Economic Policy Uncertainty Index, graphed above for the world’s five largest economies. And how, exactly, does one transform a feeling into a number? According to the researchers, articles from major newspapers are analyzed for mentions of uncertainty related to aspects of economic policy, including the decisionmakers themselves, the actions undertaken, and the effects

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FREDcast, FRED’s forecasting game, asks players to forecast four major macroeconomic variables by the 20th of every month. Some players may be frustrated by the erratic behavior of some of these indicators as they attempt to make their guesses. Fair enough. Plenty of other data analysts are in the same boat. Well, a team of researchers has been trying to quantify this sense of uncertainty using the Economic Policy Uncertainty Index, graphed above for the world’s five largest economies.

And how, exactly, does one transform a feeling into a number? According to the researchers, articles from major newspapers are analyzed for mentions of uncertainty related to aspects of economic policy, including the decisionmakers themselves, the actions undertaken, and the effects of those policies. The number of articles expressing uncertainty is standardized to the total number of articles written by each source; the accuracy of the resulting index is then tested by making comparisons with relevant indexes constructed through other methods.

The index associates historical events with the economic data. For example, the first significant spike outside of a recession in the above graph shows up in the first quarter of 2003. The spike is highest for Europe and occurred when 10 European countries were in talks to join the European Union under the condition that they’d eventually join the eurozone. The media covered these discussions in a way that uncertainty regarding policymakers, policies, and their effects came across in the index.

In 2008, as the financial crisis was unraveling, there was still much debate on what policies should be adopted and how effective those policies might be. This translated into an elevated index. Soon after, in 2011, the index spiked again in all countries. It’s likely that the uncertainty surrounding the economic and political events at the time, such as the European sovereign debt crisis and the U.S. debt-ceiling discussions, was captured by the index in this case as well.

After 2011, many nations appear to have maintained high levels of economic policy uncertainty that well surpass levels before the Great Recession. The impact of Britain’s vote to leave the European Union, several significant elections around the world, and similar newsworthy events are plainly visible in the all-time highs of the index in the past two years. If you’re not doing too well on FREDcast, you can use the pretty good excuse that there’s certainly a lot of policy uncertainty out there.

How this graph was created: Search for “economic policy uncertainty” and check the boxes next to the monthly series for the United States, Europe, China, India, and Japan. Select “Add to Graph.” Adjust the time range to begin in 1990.

Suggested by Maria Hyrc and Christian Zimmermann.

About FRED Blog
FRED Blog
The Federal Reserve Bank of St. Louis is the center of the Eighth District of the Federal Reserve System. This District includes Arkansas, eastern Missouri, southern Illinois and Indiana, western Kentucky and Tennessee, and northern Mississippi.

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