Measuring Economic Uncertainty and Its Effects

I construct a monthly index of economic uncertainty for Australia. Economic uncertainty rose to historically high levels during the global financial crisis and remained elevated until late 2013. More recently, it has been a bit below its long-term average. The index of economic uncertainty: is higher around recessions, elections, monetary policy surprises and some major geopolitical events; tends to increase faster than it decreases; and is driven by both domestic and foreign factors. I use the index to assess how uncertainty affects the Australian economy. Consistent with the 'real options' channel of uncertainty, I find that it reduces investment and employment growth. Similarly, uncertainty raises the household saving ratio and reduces consumption growth for durable goods, consistent with the 'precautionary savings' channel of uncertainty. My results suggest that economic uncertainty can be an important independent driver of economic outcomes. It is therefore worth considering in policy and empirical work.