Is there an Attenuation Bias in the Effect of Economic Policy Uncertainty? Historical Evidence from the U.S.
2020
A large and growing literature investigates the effects of economic policy uncertainty on various measures of economic activity. Virtually all of it concentrates on the modern era. We show that estimates based on post-WWII data likely suffer from an attenuation bias because the modern-period systematic government reaction function induces anticipation to policy intervention during periods of economic uncertainty. Using pre-1913 data, when active fiscal and monetary policy as well as the anticipation of intervention were absent, we find that the EPU effect on output to be four to six times larger relative to the effect measured with modern data.
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