Policy Documents

Fiscal Uncertainty and Economic Activity

Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester and Juan Rubio-Ramírez –
June 18, 2014

Over the past six years, policymakers and business leaders alike have seen the U.S. economy buffeted by larger-than-usual uncertainty about fiscal policy. As illustrated by a number of prolonged struggles at all levels of government in recent years, there is little consensus among policymakers about the fiscal mix and timing going forward. Will government spending rise or fall? Will taxes rise or fall? Which ones? And when will it happen?

One notorious example of this uncertainty is the October 2013 federal government shutdown. Other cases include the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which was signed into law just before expiration of both the Bush tax cuts and extended federal unemployment benefits; the discussion surrounding the federal debt limit in 2011, which was followed by the U.S. sovereign debt being downgraded by S&P; and the starkly different platforms in the 2012 presidential election.

Businesses appear to have been aware of this uncertainty. In the Philadelphia Fed’s July 2010 Business Outlook Survey, 52 percent of the firms that saw demand for their products fall cited “increased uncertainty about future tax rates or government regulations” as one of the reasons. Likewise, fiscal uncertainty has, in recent years, been repeatedly mentioned by respondents to the Fed’s Beige Book. And the uncertainty measures created by Baker, Bloom, and Davis (2011) suggest that, in recent years, uncertainty about fiscal policy has been greater than uncertainty about monetary policy.