Economic policy uncertainty (EPU) measures proposed by the authors and added into the 1997–2016 data set assist in estimating out-of-sample values of future actual economic activity in the Eurozone and the United Kingdom. For the period before the global financial crisis of 2008, models based on conventional financial market data can be improved by including EPU measurements for the United States, the United Kingdom, or the entire European Union. According to an AR-benchmark model, a steeper yield curve and more significant stock market gains during and following the crisis era significantly boost out-of-sample forecast performance (Junttila & Vataja, 2018). As a consequence, while EPU data is crucial throughout normal business cycles, it may contain information aspects similar to financial market return factors during periods of market and general economic instability.
Economists know that several factors can stifle companies’ employment and investment plans when it comes to evaluating uncertainty. Additionally, various types of uncertainty will have varying consequences on various sectors of the economy, most notably economic policy. For instance, a sizeable capital-intensive company may be more concerned about the pending lapse of an investment tax credit than a financial institution or store. Economic policy uncertainty is the second measure of economic unpredictability. The higher the economic ambiguity index, the more likely it is that real GDP and honest company fixed investment will drop. During recessions, there is a lot of uncertainty about economic policy and this is why it is important to note that the current business boom has had a lot of this uncertainty.
They are right when they say that macroeconomic issues like oil prices, changes in monetary and fiscal policy, and new technologies that can be used by many people are important at the micro level. It is even more important when people are making long-term investments that are hard to get back on track. By waiting for new facts to become available, the business may discover that it has a greater chance of making an informed decision. According to the author’s reasoning, there is a value in deferring investment (Junttila & Vataja, 2018). This option value will be more or less lucrative depending on the company’s sense of economic uncertainty. As an outcome, macroeconomic problems can have a big impact on business investment and the economy. When the option value is high, investors are willing to give up some of their previous gains in return for additional knowledge, according to Junttila & Vataja. There is a lot of uncertainty and the chance that new information will change how projects are ranked, so current investment is being cut back because of these things.
Many economic decisions, in my opinion, are based on what can be predicted to happen in the future. Businesses invest based on the possibility that their products will be purchased. Individuals shift residences in anticipation of a higher quality of life, college students save for a brighter future, and shareholders fund new product development in anticipation of higher profits. People need a vision of what the future might hold to make these judgments. As the adage says, prediction is challenging, especially when it involves the future. Uncertainty has always existed, but substantial increases in uncertainty like those we are currently experiencing are regarded to make it difficult to predict the future with any degree of precision. It is more difficult to make decisions that will affect the future because of this.
People use the term “option value of waiting” to describe how more uncertainty affects businesses. When confronted with an uncertain future, it makes prudent to defer key decisions until greater clarity is gained. As a response, firms delay purchases, research, and employment until it becomes clear where the economy is headed. For the same reasons, it may also slow down the process of reallocating resources to more productive usage.
Uncertainty has a direct impact on families as well. As a preventative measure in the face of uncertainty about future employment and income, families may put money away. To make things worse for their mental health, they are less likely to spend money, which makes them less happy. Companies are less confident in the profitability of initiatives that rely on consumer spending because of lower spending or the risk of lower expenditure. People also invest in their own human capital mostly through education and training, in the same way, that businesses do (Junttila & Vataja, 2018). Individuals’ willingness to make an investment will be weakened if they are concerned about the long-term benefits of doing so.
An additional way in which these effects on businesses and people are reflected financially is through the usage of derivatives. Risk increases in the presence of ambiguity. There will be an increase in interest rates and fees for investors who lend to individuals and businesses and those who buy stock in corporations. There is more uncertainty in the world, which means that projects and expenses become more expensive because of this, which in turn makes the economy less active. Another possibility is that increased uncertainty may actually spur an investment rush in anticipation of future market price spikes that could be extraordinarily high.
Reference
Junttila, J., & Vataja, J. (2018). Economic policy uncertainty effects for forecasting future real economic activity.Economic Systems, 42(4), 569-583. Web.