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What is Economic Uncertainty and Why Does it Matter?

Level:
AS, A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 7 Jan 2023

Economic uncertainty refers to a situation in which the future economic environment is difficult to predict, and there is a high degree of risk or unknowns involved.

This can be caused by a variety of factors, including political instability, changes in government policies, natural disasters, and market fluctuations.

Examples of economic uncertainty include:

  1. Volatility in financial markets: When stock prices or exchange rates fluctuate significantly, it can create uncertainty for investors and businesses. This was shown during the Global Financial Crisis and also financial uncertainty in during and after the covid-19 pandemic. Many countries have volatile exchange rates which increases the risks for businesses and overseas investors.
  2. Changes in macroeconomic policies: For example, if a government announces plans to change direct and indirect tax rates or regulations, it can create uncertainty for businesses and consumers. Likewise, uncertainty can be created when a central bank changes the direction of monetary policy and starts changing interest rates.
  3. Natural disasters: Events like earthquakes, hurricanes, and other natural disasters can disrupt supply chains and disrupt economic activity, creating uncertainty. Many countries including numerous lower-income nations have an economy highly susceptible to the consequences of climate change.
  4. Political instability: Unrest or instability in a country can create uncertainty for businesses and investors.

Uncertainty can affect behaviour in a number of ways.

For example, it can cause businesses to hold off on making investments or hiring new employees, as they are unsure about the future economic environment.

Consumers may also become more cautious about spending money, as they are uncertain about their own financial situation. This can lead to an increase in precautionary saving and a rise in the marginal propensity to consume.

When uncertainty is high, there is increased risk of an economic recession as agents hold back on consumption and investment decisions.

Overall, economic uncertainty can lead to a decrease in economic activity, as people and businesses become more risk-averse.

There are many events that have caused economic uncertainty in the past. Some examples include:

  1. The COVID-19 pandemic: The outbreak of COVID-19 and the measures taken to contain it have caused significant economic uncertainty around the world. The pandemic has disrupted supply chains, caused widespread job losses, and led to a sharp contraction in economic activity.
  2. The global financial crisis: The global financial crisis of 2007-2008 was triggered by the collapse of the housing market in the United States, which spread to other countries and led to a global recession. The crisis caused widespread uncertainty in financial markets and led to a sharp contraction in economic activity.
  3. Brexit: The decision by the United Kingdom to leave the European Union in December 2020 has caused economic uncertainty, particularly for UK businesses that trade with the EU. There are concerns about the impact on trade and investment, as well as the possibility of increased regulation and tariffs.
  4. The trade war between the United States and China: The ongoing trade dispute between the United States and China has caused economic uncertainty for businesses and investors, as it has led to increased tariffs and the threat of further economic restrictions.

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