Economic Policy Uncertainty and Real Output: Evidence from the G7 Countries

We use a new uncertainty index, proposed by Baker et al. (2016), and a relatively new methodology by Kilian and Vigfusson (2011), to assess the impact of economic policy related uncertainty on real economic activity. We use monthly data, over the period from 1985:1 to 2015:3, and impulse response functions to investigate how the economies of the G7 countries respond to positive and negative economic policy uncertainty shocks of different magnitude. We find that economic policy uncertainty is countercyclical, that the effects of uncertainty shocks increase with size, and that the responses of real output to positive and negative economic policy uncertainty shocks are country specific. Our research is important for policymaking and in favor of policies that remove economic uncertainty and its negative effects on the economy. We argue that some control over yellow journalism, a transparent tax system, and a set of predictable fiscal and monetary policies can minimize the social costs of economic policy uncertainty.