India: RBI’s new uncertainty indices could act as vital inputs for future policy making

  • A Reserve Bank of India (RBI) working paper tried to build new uncertainty indices which could act as vital inputs for future policy making. It also highlighted the need to look beyond macroeconomic and financial factors and suggested political economic aspects as source of uncertainties.
  • “Until recently, only negative macroeconomic and financial outcomes, such as fall in GDP growth, employment, stock markets, corporate earnings etc., were considered to be sources of uncertainty. However, uncertainty can also arise due to political economy factors which eventually percolate into economic policies,” said the authors of the paper — Nalin Priyaranjan and Bhanu Pratap – managers in RBI’s Department of Economic and Policy Research.
  • The authors said measuring uncertainty becomes an important task since this is not directly observable. They have built three alternative uncertainty indices using inputs as unconventional as newspaper reports or Google trends.
  • Then they have come up with one single composite index for providing a comprehensive picture of uncertainty in the economy. The conventional approach relies on finance or forecast-based measures to proxy uncertainty.
  • “Such uncertainty indices can also help strengthen policy simulation exercises to study the impact of low/high uncertainty scenarios and improve near-term projection of macroeconomic variables which exhibit a high degree of sensitivity to uncertainty,” the RBI officials said, suggesting that state-level indicators of uncertainty can also be built.
  • Less volatile economic conditions provide a conducive environment for stable growth. On the contrary, higher uncertainty hurts economic activity making the economy perform below its potential.

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