Economic Policy Uncertainty and Economic Activity: A Focus on Infrequent Structural Shifts

We provide new evidence on the role of economic policy uncertainty (EPU) in aggregate real economic activity in the US using a multiple-horizon Granger causality framework, while allowing for infrequent shifts in mean levels and growth rates of the system variables. Our empirical investigation shows that the predictive ability of EPU for economic activity significantly depends on the presence (or absence) of infrequent structural shifts and the absence from the information set of a forward looking variable such as the stock market level. We do not find economic policy uncertainty effects on industrial production once we control for stock prices irrespective of segmented trends removal. There is some evidence that EPU anticipates employment in the short-run, yet, after re-moving rare events, EPU does not anticipate employment at any horizon. In contrast, the stock market level is found to contain strong predictive direct and indirect information for economic activity that is robust to the presence of infrequent trend breaks