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Will a hung parliament bring economic uncertainty, and how damaging is that?

Will a hung parliament bring economic uncertainty, and how damaging is that?

After the Australian election, and after Brexit, learned authorities in dark suits are shaking their heads. 'Times are especially uncertain', is their grave assessment. It begs the question: when are times especially certain?

But I digress. That financial markets hate uncertainty seems quite plain. You just need to look at the reaction after Brexit. But what about the wider economy?

The last decade has seen an explosion in research on the effects of uncertainty. Nicholas Bloom of Stanford University has been one of the most important drivers of this research agenda. In a series of papers, Bloom has thrown the gamut of statistical and modelling machinery at the topic. The verdict? Uncertainty shocks can be important. In response to uncertainty shocks, firms delay investment and hiring decisions. It is relatively costless for firms to delay these decisions until the uncertainty resolves itself. What is good for the firm, however, is bad for the economy. Less investment and fewer jobs is the result; the economy enters a downturn.

The UK Treasury put out a paper in April looking at the short-run consequences of Brexit. It predicted a recession if the 'Leave' vote was successful. The effects of uncertainty are likely to have played an important role in that prediction. We can't tell exactly how much, because there are other factors driving the result, and the UK Treasury did not parse out the effects of each factor (at least I couldn't find it), but the work seems statistically sensible. They wheeled out a vector-autoregression (never mind) to assess the effects of uncertainty, and at first glance, all the work seems sensible.

However, the effect of the uncertainty is...uncertain. One key assumption of the Brexit study was that uncertainty would remain elevated for two years. That's uncertain.

Nicholas Bloom, in concert with a couple of other economists, produced an uncertainty tracker. The graph below shows that the uncertainty tracker was going up before the vote.

And after the vote? Well, they don't have high frequency data for the UK. But they do for the US, where the uncertainty index went up but has since come down again (see the graph below). In any case, the next few readings for the UK will be followed like never before. [fold]

Paul Krugman had a couple  of posts on uncertainty and Brexit last week. He questioned whether we were in fact being too pessimistic about the short-run consequences of Brexit. I have some sympathy for his arguments. First, the two years of elevated uncertainty assumed by the UK Treasury seems pessimistic. Second, while the statistical tests run buy the UK Treasury to assess the effect of uncertainty are sensible, they are by no means guaranteed to give the right answer. The statistics on uncertainty are, you guessed it, uncertain.

Where does this leave Australia? We are hearing many comments about how the hung parliament is going to be bad for economic activity. Maybe, but other countries seem to handle political uncertainty OK. And we have too, in the past. Below is a graph of GDP growth over the last few parliaments. The political warriors will make what they will from this graph. However, I think it is difficult to conclude that the hung parliament of 2010-13 was especially damaging.




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