Forecasting US recession with the economic policy uncertainty indexes of policy categories

Abstract

Uncertainty about the future affects economic decisions today since there is an option value to postpone economic decisions. Using the economic policy uncertainty (EPU) indexes of policy categories developed by Baker et al. (2016), this study estimates the probit model to predict the recession probability in the United States, and quantifies the relative significance of the category-specific EPU indexes. The EPU index of national security is found relatively useful as predictors of recession. This category-specific measure of uncertainty provides information about the occurrence of recession that the other variables do not contain.

Forecasting economic policy uncertainty of BRIC countries using Bayesian VARs

“…But, Baker et al (2016) has solved this problem by constructing normalized indexes of the volume of newspaper articles discussing economic policy uncertainty (EPU) for a large number of developed and developing economies. Using these news-based measures of uncertainty, empirical validation of the theoretical prediction that heightened uncertainty leads to recessions for both advanced and emerging countries can be found in the recent works of Karnizova and Li (2014), Balcilar et al (2016), Kurasawa (2017), Junttila and Vataja (2018), Aye et al (2019a,b), Pierdzioch and Gupta (2017). Despite the well-established importance of uncertainty in macroeconomic developments, both theoretically and now empirically, there is no systematic effort to forecast uncertainty that will allow policymakers to act upon such forecasts while making their decisions in terms of designing appropriate policies ahead of time to deal with future business cycle downturns.…”