RBI's new uncertainty indices could act as vital inputs for future policy making

A Reserve Bank of India (RBI) working paper tried to build new uncertainty indices which could act as vital inputs for future policy making. It also highlighted the need to look beyond macroeconomic and financial factors and suggested political economic aspects as source of uncertainties.

The paper titled “Macroeconomic Effects of Uncertainty: A Big Data Analysis for India”, confirmed that uncertainties affect firms’ decision to invest in capital or hire labour as well as consumers’ decisions on buying goods and services.

“Until recently, only negative macroeconomic and financial outcomes, such as fall in GDP growth, employment, stock markets, corporate earnings etc., were considered to be sources of uncertainty. However, uncertainty can also arise due to political economy factors which eventually percolate into economic policies,” said the authors of the paper — Nalin Priyaranjan and Bhanu Pratap – managers in RBI’s Department of Economic and Policy Research.

The authors said measuring uncertainty becomes an important task since this is not directly observable. “The lack of a clear definition of uncertainty makes the task of measurement even more difficult.”

They have built three alternative uncertainty indices using inputs as unconventional as newspaper reports or Google trends. Then they have come up with one single composite index for providing a comprehensive picture of uncertainty in the economy.

The conventional approach relies on finance or forecast-based measures to proxy uncertainty.

“Such uncertainty indices can also help strengthen policy simulation exercises to study the impact of low/high uncertainty scenarios and improve near-term projection of macroeconomic variables which exhibit a high degree of sensitivity to uncertainty,” the RBI officials said, suggesting that state-level indicators of uncertainty can also be built.

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Statements, actions and decisions taken by policymakers with respect to fiscal, monetary, structural and regulatory policies can also affect the wider economy and its future outcomes.

“Hence, it is important to understand the nature of uncertainty that may arise from different sources and analyse its likely impact on domestic economic activity and financial markets,” the paper said.

To be sure, less volatile economic conditions provide a conducive environment for stable growth. On the contrary, higher uncertainty hurts economic activity making the economy perform below its potential.



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