The Economics of Uncertainty – Introduction
We have all faced situations where we don't want what to expect in the future, yet we need to make impactful decisions. Decision-making is one of the most important aspects of any economy. Consumers and producers, firms, and households are all faced with a decision-making dilemma on a daily basis. It is one thing to make just any decision and a different thing to make the right decision. As you may already know, these decisions affect the general outcome and growth of an economy. There is a need to understand the risks involved in making decisions so that we can create a better economic environment.
The economy of uncertainty is the study of economic uncertainty. This is where the future of the outlook of an economy looks unpredictable. When economic analysts talk about economic uncertainty, they are talking about the high likelihood of negative economic events. In other words, economic uncertainty could involve:
- The forecast for higher or more volatile inflation. The rate of inflation cannot be predicted right, and the chances of going high are certain. In this, any decision made by all stakeholders is either to prepare for the worst, to hope things don't get as bad.
- A possible economic downturn. Ups and downs define economic growth and development. When an economy is on a constant growth path, everything seems right as inflation and unemployment rate are low. However, economic growth can be defined as elastic, which means it has an endpoint. Once it hits the peak, economic uncertainty falls in with lower growth or negative growth.
- Concerns on prospects of the exchange rate. The strength of a country's economy determines how much imports and exports they will get. A weak currency may chase away investors and make it hard to export a country's products. A rapid devaluation of the currency defines economic uncertainty. It can be very difficult to recover from such a situation if policy-makers don't step in to save the economy.
- Fear of unemployment. An increase in demand determines positive economic growth. Firms will need to make more goods, which means they will employ more people, reducing the rate of unemployment. Household consumption is also at its peak with more spending and less saving. That is how an economy grows. In times of economic uncertainty, people will fear the prospects of losing their jobs. An economy can easily get into a state of panic when this happens, worsening the impact.
- Concerns over government borrowing. Economic uncertainty can affect the lending industry with large scale impacts. For instance, the markets may become unwilling to finance more debt, which leads to default. Public debt is an indication of a healthy economy, but bad things begin to happen to the economy when it goes too high. This is where economic uncertainty is more pronounced.
- Major changes in the economic structure. When there is no clear prediction of economic growth, major economies have to change the structures. In a recent example, the U.K. exited the E.U. because of uncertainty.
What does economic uncertainty look like in major economies?
Economic uncertainty is more impactful on major economies. They are at a higher risk of losing their markets since their growth and sustainability depend on their markets' strength. Let's take the U.K. case; for instance, economic uncertainty can be shown using different data from the Bank of England. Analysts use different data and information from past experiences to draw the future of the economy. If it looks like things are taking the low road at some point, policy-makers come in to shield both consumers and producers. The bank could use a forecast chat of possible forecasts of economic growth. This is important because understanding the economic path helps governments prepare for a bad economic state. And the economic chart forecast chart is made with one central line at the center that shows the economy's real situation. But it is followed by a range of fan that shows all the possible outcomes of the economy. The further we try to look into the fan, the harder it becomes to predict that economy's future, which makes the fan grow even wider.
The U.S. labor market is getting tighter by the day. A few months ago, the unemployment rate was a low that was also recorded in May 2001, just before the financial crisis. It is clear that wage growth has somehow recovered. It stood at 0.9% in April last year, which was more than its 4.5% peak in 2007. Unfortunately, the U.S. wage growth picked up as expected, which raises a lot of questions about the state of general economic growth in major economies. In a recent headline, the rate of unemployment has fallen, but underemployment has continued on an upward scale. And it could be that so many details have been left out. There was no data on workers doing part-time in the first official headline concerning unemployment, yet would like more hours. There are also those who have given up looking for jobs because they have been discouraged by different forces. These categories are supposed to be taken in by the U-6 account, which is still higher than the pre-crisis level.
There are always signs of economic uncertainty. For instance, another aftermath of the U.S. crisis has seen through its job-rich and wage poor recovery. This means jobs have been created, but wages are too low. Employees are still under-utilizing, yet there seems to be a larger than normal proportion of new jobs. By the second quarter of 2018, the labor market slack was on track, which meant wages would likely never increase. Different analyses showed that U-6 unemployment was constantly decreasing, and would have fallen below the pre-crisis levels in January of 2018.
The U.S. economy continued to grow positively throughout the 2018 and 2019 periods until January 2020 when the coronavirus pandemic hit. The rate of unemployment skyrocketed as many parts went on lockdown to control the infections. Despite all the interventions, the first few months witnessed some of the worst-hit situations of any economy. The closure of economic activities brought out another huge impact on general economic growth and development. Consequently, we have seen several cases of inflation uncertainties that make things even harder for governments.
When large economies are suffering, third-world economies also face that hardship. Although they don't feel the full impact because their markets are not fully developed, it is strong enough to cause serious damages. It takes back every attempt to create a fully functional economic system,
What causes economic uncertainty?
As an economy student, one of the topics you will meet is understanding economic uncertainty causes. It is very critical to creating policies that shield economic development. Some of the causes include:
A proper supply of goods and services is a good indication of economic stability. It means consumption is high, and the firms are getting their profits and revenues flawlessly. However, an economy may not fully enjoy growth in supply because of unbalanced markets. For instance, when there is an unexplained rise in oil or commodity prices, it leads to an increase in production costs from the firms. It will lead to what is called, in cost-push inflation. A supply-side inflation cause stagflation, which is a combination of higher inflation a lower economic growth.
Supply-side shocks are common threats to economies. And they are not very easy to deal with. Central Banks can, for instance, fail to resolve inflation and low growth rates even when they adjust interest rates. In this case, they will have taken measures than can lead to further deterioration of economic health. Interest rates are used to target lower inflation or higher growth, but not all at ones. This means, if the first approach does not work, they will need to look a the other, which takes time and resources.
It is not only supply that faces these shocks, but supply can also be an issue. In fact, a global economic downturn will have a strong impact on reducing growth in all countries. For instance, when there is a recession in the E.U., the whole of U.K. exports will be affected, further affecting economic growth across the region. Many countries have signed trade treaties that enable them to exchange goods on different levels. If one country is going through economic difficulties, it means they may not be able to export their goods to other regions. This means the supply of goods will be highly affected. Also, if workers go on strikes, it leads to high demand in the labor market.
Banks and other financial intermediaries play a vital role in economic growth. They determine how much money flows and business work but lending money to borrowers. This means bank closures can have huge negative impacts on the banks by causing loss of confidence in the financial systems. When this happens, people start withdrawing their money from these banks, leading them further into worse situations.
Uncertainly on the global economy
Economic uncertainty has always been an issue in many markets. When economies begin facing challenges, people become concerned about their futures. This means they begin making decisions based on what seems like more beneficial steps. Some of these decisions may end up hurting economies even more. For instance, if savers panic and begin withdrawing their money from banks in masses, it can lead to such banks' failure. If it continues further, financial markets would be in even bigger trouble, which flows into the real economy.
Another example of uncertainty is what is being witnessed over the current state of the U.K./Global economy.
There is uncertainty over the future of the Euro. Many analysts have failed to determine whether Greece, Portugal, and Italy will survive without defaulting on their debts and abandoning the Euro. If the break up in the Euro happened, there would be a huge credit crunch that could cause a severe European Recession. The prospects for European economic growth have remained under long debates. The Euro may survive, but it will be at a very high cost. Countries have turned back to serve austerity measures to reduce European budget deficits, which could reduce economic growth. There is also a clear imbalance in the Eurozone because of the single currency, potentially causing continued stagnation. Unemployment will also increase even as different policies are made in an attempt to reverse these situations.
Businesses on uncertainty
The global business community is concerned about uncertainty. It goes to roll in CEOs' minds, and some of the latest global CEO surveys indicate 'uncertainty economic growth' has become a huge threat to firms.
Different statistical figures have been used to measure levels of uncertainty in economies. And they all seem to agree that businesses are highly threatened by uncertainty. For instance, the Economic Uncertainty Index (EPU), which follows policy-related uncertainty paths, was at its peak at an all-time high at sometimes ago. They were quite higher than what was seen at the 2008 crisis.
Uncertainty does not only affect business but the entire economy. It flows right through households, businesses, and financial markets. For households, the situation could lead to reduced consumer spending in different sectors of the economy. This is also associated with precautionary household savings. In other words, there is more saving and less spending in households, which affects economic growth. In the U.S., for instance, there was an increase of around 5% in point during the 2008 financial crisis, rising from 3% to 8%.
Uncertainty can also push businesses to cut back on production, saving, and employee compensation. The large capital project tends to have a higher measure of irreversibility and may be more sensitive to uncertainty. This issue extends to financial markets where investors call for a higher rate of return on their capital. This could lead to an increase in the cost of credit.
We are all faced with uncertainties in different aspects of our lives. The consumer and producer theories indicate that households and firms make decisions based on the amount of risk involved. This means uncertainty is normal, and we must learn how to survive it.
Author: James Hamilton