The Federal Reserve doesn’t actually name the wayward occupant of the White House in its new report attempting to gauge the recent spike in trade uncertainty—but the measure might as well be called the Trump Index.
Fed board economists have developed three separate ways to gauge trade policy uncertainty, based on textual analysis of firm’s earning calls and newspaper coverage, as well as from aggregate data on import tariffs.
“All measures suggest that uncertainty about trade policy has recently shot up to levels not seen since the 1970s,” the Fed board researchers find.
The study of trade, long relegated to second-class status in the field of economics, has now infiltrated the broader macro debate in an unavoidable way.
The Fed paper notes that “for decades prior to these trade developments, there was limited volatility in trade policy, and thus limited study of the impact of uncertainty regarding trade policy on the economy.”
Now that the issue is back at the forefront, the authors try to “fill that gap—developing measures of uncertainty at both the firm and aggregate levels, estimating the effects of these measures on investment, and then interpreting these effects.”
They find that a shock of the magnitude experienced around the world in 2017 and 2018 “predicts a decline in the level of aggregate investment of between 1% and 2%.”
“Moreover, such predictions are in line with recent survey evidence that directly asks firms how they reassessed capital expenditure plans in response to higher trade uncertainty,” the authors add.
They are also in line with figures in the second quarter Gross Domestic Product report showing a sharp 10.6% drop in business investment.
The Fed board research is timely. Fed officials justified their July reduction in interest rates on the basis of an increasingly uncertain outlook, in large part due to the trade war Trump started.
“Participants generally judged that the risks associated with trade uncertainty would remain a persistent headwind for the outlook, with a number of participants reporting that their business contacts were making decisions based on their view that uncertainties around trade were not likely to dissipate anytime soon,” according to minutes from that meeting.
The Fed is expected to cut interest rates again next week against a backdrop of slowing economic growth and weakening employment gains. The U.S. economy added just 130,00 jobs in August, and wage growth has again stalled, indicating the labor market is still not firing on all cylinders despite a low 3.7% jobless rate.
As long as Trump remains in office, and likely longer, the outlook for trade will be key to the future monetary policy.