Local COVID Lockdowns Fed Economic Policy Uncertainty

As COVID-19 spread across the United States and world in 2020, uncertainty about the pandemic’s effects rattled the economy. The crisis also had localized effects on policy uncertainty in individual US states, and those effects were particularly strong in places with strict lockdowns, according to Northwestern’s Scott R. Baker, Chicago Booth’s Steven J. Davis, and University of Chicago Harris School of Public Policy’s Jeffrey A. Levy.

Baker and Davis, along with Stanford’s Nick Bloom, have pioneered the study of policy uncertainty, quantifying how much it affects the economy. Policy uncertainty depresses economic activity by causing companies to defer investments, by raising the cost of borrowing, and by prompting consumers to postpone purchases. The researchers’ website hosts dozens of indexes that track economic policy uncertainty (EPU), including nearly 30 focusing on EPU levels in countries around the world.

But uncertainty also matters at the state and local level, find Baker, Davis, and Levy—and they quantify how much EPU levels can vary from one place to another. Not only do state policy makers respond to national issues differently, they also establish distinct regulatory regimes closer to home. State and local governments exercise sweeping powers over taxation, land use, business and occupational licensing, education, minimum wages, jobless benefits, and environmental, health, and safety regulations.

To analyze EPU at the state level, the researchers applied the same general methodology used to measure EPU elsewhere: they recorded how often newspaper articles discussed economics, policy matters, and uncertainty. In this case, the researchers analyzed digital archives for nearly 3,500 local US newspapers from January 1985 onwards, excluding national papers such as the New York Times and the Wall Street Journal. They identified terms relating to state and local government agencies, uncertainty, policy, economics, and other issues.

Other researchers have measured policy uncertainty at the local level, they acknowledge. But unlike them, Baker, Davis, and Levy constructed three separate monthly indexes of economic policy uncertainty for each state. One captures state and local sources of uncertainty, a second captures the national and international situation, and a third generates a composite of the first two.

“Half the articles that feed into our composite indexes discuss state and local policy, confirming that sub-national matters are major sources of policy uncertainty,” they write.

The researchers find that elections are recurring sources of state-level policy uncertainty, with the models predicting that a narrow gubernatorial race increases state-level uncertainty by 35 percent, while a close presidential-election contest raises it by 60 percent.

Other state-level index drivers include the California energy crisis of 2000–01, the California gubernatorial recall of 2003, and the Kansas tax experiment of 2012, which involved steep tax cuts that were eventually repealed.

Increased levels of policy uncertainty tend to foreshadow higher state-level unemployment and lower employment, with peak responses of modest size about a year later, according to the study. Uncertainty also tends to presage lower home prices and fewer new permits for housing construction. The negative economic effects of policy uncertainty in one state also spill over to bordering states.

The researchers find rising general levels of uncertainty over time, in addition to discrete jumps in response to events including the September 2001 terrorist attacks, the 2011 debt-ceiling crisis, federal government shutdowns, and the 2008–09 financial crisis. They single out the pandemic for having driven huge increases in policy uncertainty and unemployment, particularly in states that imposed stricter lockdowns. Across the country, the pandemic pushed up the average level of state-level policy uncertainty, write Baker, Davis, and Levy. Their indexes for state and localy sources of policy uncertainty soared to an average of more than four times its previous high.