Don't Blame the Sluggish Economy on Uncertainty Alone

Don't Blame the Sluggish Economy on Uncertainty Alone
Don't Blame the Sluggish Economy on Uncertainty Alone

The Federal Open Market Committee's post-meeting statement released on Aug. 10 was a reminder that this recovery won't come easily. It turns out that the Fed's previous predictions for economic growth were too optimistic.

The spending, housing and credit numbers that might signal sustainable progress are sluggish. Output and employment, the drivers for these factors, aren't improving at a meaningful pace.

Thus, the blueprint for growth seems simple: Increase output and employment, and the recovery should take off. What is stopping this from happening?

The Magic Word

While there are all sorts of explanations, ranging from changing demographics to bond vigilantes, one common force bears much of the blame for this lethargic economy. Probably every financial writer, pundit and analyst has cited this reason in some context: "uncertainty." It's arguably the financial world's most familiar explanation, and rightfully so.

After all, it's at least partially correct to say uncertainty is the reason businesses aren't hiring. Consumers are uncertain about their jobs, so they're not spending. Banks are uncertain about whether their potential borrowers can pay them back, so they're not lending.

However, the same justification could fit any situation, and even support the opposite argument. To say that something is certain is to effectively predict the future, which no one can do, despite how predictable things may seem. This is the case whether things are going well or going down the drain, whether unemployment is at a fantastic 4% or a dismal 25%.

What happened the last time something seemed dead-certain in the financial world? It was "certain" that housing prices were always going to increase. To say that ended poorly is the understatement of this young century.

Certainty is an illusion, and when things are going well, it's easy to claim there's certainty. Optimism creates an irrational state of mind because people naturally want to see good conditions and be certain about them.

So Why the Fuss?

It's true that more uncertainty can be infused into a situation. Much of the current inaction by consumers and businesses is blamed on there being more uncertainty than usual. However, this blame is largely misplaced because there is no real "usual," and additional uncertainty by itself does not cause inaction.

Consider the example of inflation: As any economics textbook will explain, when prices are rising, consumers tend to buy more and businesses tend to hire more. This is because inflation today suggests that the trend will continue, causing both prices and wages to be even higher tomorrow. Future prices cannot infallibly be foreseen, and they become more uncertain as they rise, but price growth still spurs spending. Because the fear of more inflation exists, businesses and consumers act.

In that situation, uncertainty actually breeds expansion, creating conditions that prompt consumers to spend or not spend, businesses to hire or not hire.

Uncertainty Is Not the Enemy

With inflation, it is the prevailing expectation that prices are lower today than they will be tomorrow that prompts action. The actors are biased to believe that what happens tomorrow will make today's decision a good one. If the bias were that tomorrow's facts would make today's decisions appear poor, indecision would result. A positive bias is confused with certainty, and a negative bias becomes uncertainty.

The government is the party often held responsible for today's uncertainty and often accused of adding to the pessimistic bias.

The new health care law imposes new charges on employers and contains over 200 instances in which the government "may" do something. The financial regulation law has similarly vague clauses and has provisions to charge banks for a rescue fund. Federal deficits are at record levels, and will have to be paid down. Social Security will too. Anything could happen with the soon-to-expire Bush-era tax cuts.

All of these government issues undoubtedly produce uncertainty. What is important is that they generate the expectation of higher future costs and taxes for consumers and businesses. Therefore, employment and output suffer.

It is already expensive to hire more workers. A New Jersey business owner calculates that it costs his company $74,000 to pay an employee a salary of $59,000, and after deductions and taxes, she only takes home $44,000. This business owner is not alone. Because of the problems facing the U.S., and its recent actions to solve others, there's a collective bias to believe that further changes would make hiring even more expensive.

So Blame Obama?

It is easy to see why there is a reluctance to spend or hire. Any decision that meets already tight criteria and seems like a good idea today could easily be invalidated by tomorrow's legislation. This is the expectation that the government is creating.

It is a completely different issue of how guilty this current administration is in producing and maintaining this bias. It inherited many of its problems, and there were no easy solutions to those issues. Even if it had taken all the right actions, there is no telling what bias the American people would now have.

Judgment about the administration's choices would probably still be divided across partisan lines. But this is less important than what it will do to fix this predicament. It must create a positive bias in its people that there will be a bright tomorrow and today's decisions will still be good decisions by future standards. The administration has the job of convincing businesses, consumers, and investors alike. This is no easy task, but recognizing that it is fruitless to battle uncertainty alone is a key first step.