engleski

Economic policy uncertainty index and economic activity: what causes what?

This paper is a follow-up on the Economic Policy Uncertainty (EPU) index, created in 2011 by Scott Baker (Northwestern University), Nick Bloom (Stanford University) and Steven Davis (University of Chicago). The principal idea of the EPU index is to quantify the level of uncertainty in the economic system, based on three separate pillars: news media reports focusing on economic uncertainty, the number of federal tax code provisions expiring in the following 10 years, and professional forecasters’ disagreement on the future tendencies of relevant macroeconomic variables. Although the original EPU index is designed and published for the US economy, it instantly caught the attention of many academics, even Paul Krugman who severely criticized it for its potential methodological flaws. Because of this growing interest for EPU, the index was rapidly introduced in as much as 13 world countries. A wide academic debate has been triggered on the importance of economic uncertainty for the intensity and persistence of the recent crisis. Despite the intensive (mostly politically motivated) debate, a formal scientific confirmation of causality running from the EPU index to economic activity has not followed. Moreover, the empirical literature has completely failed to carry out formal econometric testing of Granger causality between the two mentioned phenomena. This paper will provide an estimation of the Toda-Yamamoto causality test (to take into account the different integration orders of the observed variables) between the EPU index and economic activity in the USA and Europe (aggregate level). Since it has been hypothesized that the EPU index grows in significance in the crisis period, special attention will be devoted to examining the potential differences in the obtained results before and after the Great Recession of 2008.

economic policy uncertainty index; granger causality; economic uncertainty

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