Uncertainty has a big impact on the behaviour of households and companies, in particular when the decisions are essentialy irreversible and imply a long commitment period (residential and corporate investments). Uncertainty impacts the economy via shocks (unexpected events) and second round effects, which explain why it can linger on for a long time. Shocks can concern economic or non-economic developments (e.g. political or geopolitical). The future evolution of economic numbers is an ongoing source of uncertainty: think of the reaction of inflation to a decline in the unemployment rate.

Economic policy can also influence uncertainty and, based on the empirical literature on the negative consequences of uncertainty on economic growth, the case for avoiding that economic policy complicates things further is obvious. That is why central banks provide guidance on their policy intentions and why they try to react to new information in a predictable way: a stable reaction function keeps a lid on uncertainty. The impact of fiscal policy on uncertainty is less clearcut: a countercyclical fiscal expansion should reduce it, provided there is policy space whereas a procyclical impulse (recent US tax cuts), only adds to inflation pressures thereby eventually increasing uncertainty.

Trade policy, defined as protectionist measures, generates uncertainty in different ways:

  1. the threat of import tariff increases (interestingly they can create an illusion that the economy is doing fine judging by the evolution of imports, even though the latter are only rising in anticipation of tariff hikes);
  2. the concern about retaliation by the trading partners;
  3. worries about the impact on inflation, bond yields, exchange rates and the outlook for monetary policy;
  4. the complexity of analysing how global value chains are impacted;
  5. concern about how tariffs eventually lower the competitiveness of the protected economic sectors.

Media coverage of protectionism

A characteristic of uncertainty is that at some point a tipping point is reached. Fundamentals like capacity utilisation, profitability, cost of borrowing may still be very good, but if uncertainty is high and perceived to last, investment growth will still end up suffering because of the lack of visibility: the drop in confidence is the straw that breaks the camel’s back despite good fundamentals. What follows are knock-on effects on hiring decisions, consumer confidence and spending. For the time being, US sentiment data do not point in that direction but an increasing number of companies expressing their concern is a useful reminder of what is at stake.