Policy Uncertainty Hitting Job Creation: Fed Report

Small businesses would hire and invest more if Washington offered a clearer idea about plans for taxes and government spending, researchers at the Federal Reserve Bank of Cleveland said on Tuesday.

Measuring the impact of policy uncertainty has long dogged economists. The question of its impact is particularly relevant now because measures of uncertainty have spiked in recent years.

The issue also colors the political debate on the regulation of banks and the healthcare market, and whether to extend tax cuts that could prop up economic growth next year.

The Cleveland Fed researchers used an index that measures uncertainty by the amount of newspaper coverage on the topic, as well as how many tax policies will expire in the coming year absent action and how much forecasters disagree on future government spending and inflation.

This index, they found, correlated tightly with small business plans to hire and invest, as measured by data from the National Federation of Independent Business going back to 1986. The NFIB data was used because it signals broader economic trends in employment and investment.

"While the downturn and weak recovery certainly had a large negative effect on small business hiring plans, policy uncertainty has exacerbated this effect," researchers Mark Schweitzer and Scott Shane said in their report.

The percentage of businesses planning to hire would have been 6 points higher in the summer of 2011 if not for the effects of uncertainty, they found. The toll on capital expenditures, which include investments in equipment and buildings, was similar.

The policy uncertainty index, which goes back to 1985 and was developed by economists at Stanford University and the University of Chicago, rose to an all-time high over the summer as a budget debate in Washington brought the government close to the brink of being unable to pay its bills.

The index also has spiked around presidential elections and the two U.S. invasions of Iraq during the period.

Schweitzer and Shane said their research should serve as a warning to policymakers, who critics say have shirked their responsibility to make tough decisions about long-term policy.

"Policymakers should take seriously the widespread anecdotal reports that policy uncertainty is adversely affecting small business owners' expansion plans," the report concluded.