Thursday, January 24, 2013

How Consumer Uncertainty Affects Unemployment and the Economy

 While employment numbers in the United States have shown modest improvement since the depths of the Great Contraction, America's employment picture is far from robust.  A brief Economic Letter by Sylvain Leduc and Zheng Liu of the Federal Reserve Bank of San Francisco helps to explain one previously unquantified but common sense factor that has led to elevated unemployment since 2008; uncertainty.

It makes sense that uncertainty affects economic output and, as a consequence, employment levels, however, the impact of uncertainty has not previously been quantified.  Here is a chart showing two types of uncertainty, consumer's perceived uncertainty as measured by the University of Michigan Surveys of Consumers and the Confederation of British Industry Industrial Trends Survey and the VIX index, a standard measurement of stock market volatility:

This chart shows that both indices rise in recessions and fall when the economy is expanding, most recently surging in 2008 as the Great Recession took hold.  You'll also notice that sometimes the two indices act independently of each other, for example, during the 1997 - 1998 Asian/Russian crisis, the VIX rose but American consumers were relatively unfazed.  You will also notice that even though we are nearly four years into the so-called recovery, that both the VIX and consumer uncertainty remain at elevated and very volatile levels compared to most other inter-recessional periods.  That is key to the problem in today's economy.

The authors found that an increase in uncertainty by consumers in the aforementioned surveys affected the unemployment rate, inflation rate and nominal interest rate for a period of time as follows:

Note that the shaded area reflects the 90 percent probability range for the increase in uncertainty and the solid line reflects the median probability.

As consumer uncertainty rises, the unemployment rate rises as shown on the first panel and then begins to fall after 20 to 24 months, inflation falls for the first 12 months and interest rates fall for the first 20 to 24 months after the initial shock.  This finding suggests that the actions taken by the Federal Reserve and their counterparts around the world to push nominal interest rates lower have had the affect of accommodating increased uncertainty. 

The impact of an unexpected increase in consumer uncertainty acts like a decline in overall demand in the economy.  This means that central bankers face no tradeoff between keeping inflation under control and maximizing employment, a situation that would occur if the increase in uncertainty pushed supply down.

With the fact, as seen in the chart showing consumer uncertainty and the VIX, that uncertainty was much greater (and still is) during the Great Recession, the authors calculate that the uncertainty factor alone during and after the Great Recession was responsible for pushing the United States unemployment rate up by between one and two percentage points since the crisis began in 2008.  This means that the unemployment rate would have been between 6 and 7 percent rather than between 8 and 9 percent had uncertainty not played such a critical role.

As you will note on the first chart, consumer uncertainty played a nearly negligible role during the 1981 - 1982 recession.  During that recession, the Federal Reserve had plenty of room to dramatically lower interest rates as shown on this chart:

Such is not the case since 20068 - 2009.  This time, things really were different on more than one front.  With interest rates already near or at zero percent, the Fed has boxed itself into a policy corner from which there is no means of extrication except through the creative use of untested experiments like Quantitative Easing 1, 2 and 3 and "The Twist".  While uncertainty deepened the recession, the fact that interest rates cannot be lowered any further has prevented the economy and, by extension, the unemployment picture from meaningful improvement.

Oops!  So much for central bank intervention.


  1. False...The VIX went to 96...and it is now at 12 which is not elevated...

  2. The VIX is merely there for information purposes. The perception of consumer uncertainty, while down from its peak, is still elevated compared to normal economic boom times.