Commentary: Congress’ Deadliest Weapon? Uncertainty.

Commentary: Congress’ Deadliest Weapon? Uncertainty.

10/10/2013 BY: PETER MUOIO, PH.D., AUCTION.COM RESEARCH

The federal government shutdown is center stage in the news and the question that is repeatedly asked is: “What impact will it have on the economy?”

Of course, the potential economic impact will be difficult to gauge because the shutdown has stopped the flow of government data releases until the funding battle is resolved. Luckily, in our view, one key indicator remains live, touching on what we see as the most important transmission mechanism for the government shutdown to affect the U.S. economy: uncertainty.

While many analysts cite varying reasons for the tepid, start-stop nature of this recovery-which has been the slowest in modern record-we attribute much of the lethargy and seesawing of growth since 2010 to the heightened level of uncertainty that has gripped consumers and businesses over that time. When faced with uncertainty, the natural human reaction is to hold back before deciding to act, and this collective behavior has limited household spending and business investment.

Throughout this year we have noted a decline in uncertainty from the elevated level of the past five years to below the high range that had persisted since 2008, and we have viewed it as a potential trigger to unleash the private sector. We do not believe it is coincidence that consumer spending and private investment (including residential investment) have become the primary drivers of re-accelerating gross domestic product (GDP) growth over the first half of this year following last year’s economic stall.

However, as the potential for a government shutdown loomed over the summer, we recognized the potential for renewed uncertainty sparked by a budget and debt ceiling fight to reverse the burgeoning virtuous cycle between lower uncertainty and stronger, more consistent growth by derailing household and business spending.

Since the Economic Policy Uncertainty Index is calculated and published by a group of academic economists at Stanford and the University of Chicago, and is available on a daily as well as monthly basis, it provides a clear window into how individuals and businesses are reacting to the government shutdown and therefore how large of an economic impact it could have.

So far the uncertainty index, which uses meta-data techniques to measure uncertainty, has shown a nuanced reaction to the shutdown. Initially, there was a very ominous jump in uncertainty to levels not seen since early 2013, peaking on October 1, the first day of the government shutdown. Since then, there has been some diminishment in uncertainty but to a level that is still well above the more benign readings seen this year prior to the run-up to the shutdown.

Other gauges confirm what the uncertainty index is signaling. Gallup’s Economic Confidence Index has collapsed amid the government shutdown, posting its worst three-week plunge since the fall of Lehman Brothers. The VIX index of stock market volatility, which is a traditional gauge of investor worries, also jumped.

However, the edging down of uncertainty in recent days and a similar easing in VIX volatility suggest recent signs of potential movement toward resolving the shutdown are being received positively by households, businesses, and investors. If this movement toward resolution is sustained, the economic impact of the shutdown could be minimal. However, the longer the shutdown and fight over the budget and debt ceiling drag on, the higher uncertainty is likely to go and the more damage it will inflict on spending and investing.

The stage is being set for another potential late-year economic stall that could be worse than econometric models are currently projecting.

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