Uncertainty, policy, and recessions

Via Anti Dismal, there is a post discussing regime uncertainty and recessions – and criticising some of the world’s Keynesian bloggers for ignoring the role of uncertainty.

Now I think the real options argument that uncertainty reduces activity is undeniable, but I also don’t think that any economist – Keynesian or not – disagrees with it.

Ultimately, we know uncertainty is a major driver of the business cycle – that is part of the reason why investment is the first thing to pull back, and one of the first things to recover when a “recovery in the economy” begins.

The difference lies in what CAUSES the uncertainty – specifically, when we think about the role of government in this context we need to ask “will this government action increase or decrease uncertainty for decision makers”.

We don’t live in a world where, without government, there is no uncertainty – in fact uncertainty appears “endogenously” during the economic cycle, it is something that is both always there and worsens when things change.  The real question isn’t whether uncertainty has a cost (it does) it is whether policy (which is what we control) makes things better or worse.