119. Stock Markets, the Economy, and Trump's Trade Policy Uncertainty

Episode Summary

Executive Summary: The episode examines how uncertainty affects trade and the wider economy, drawing on Nick Bloom’s research. It explains two main channels—risk aversion and real options—shows that uncertainty is strongly correlated with weaker growth and especially lower investment, and discusses how Bloomberg’s newspaper-based Economic Policy Uncertainty Index captures historical spikes and today’s surge in trade policy uncertainty under Trump.

Main Topics: How uncertainty affects economic behavior (Priority: 5/5): Bloom explains that uncertainty makes firms and households pause decisions: firms delay investment and hiring, while consumers postpone spending on durable goods. This slows economic activity across the economy. Two theoretical channels: risk aversion and real options (Priority: 5/5): The discussion distinguishes between uncertainty raising perceived risk/cost of capital and the option value of waiting, both of which discourage spending and investment. Evidence linking uncertainty to growth and investment (Priority: 5/5): Bloom says uncertainty is strongly correlated with lower growth and particularly investment, though causality is harder to prove because weak growth can also increase uncertainty. Building and interpreting the Economic Policy Uncertainty Index (Priority: 4/5): The episode explains how the EPU index is built from newspaper mentions of uncertainty plus policy terms, why newspapers are used, and how the index tracks major historical events. Trade policy uncertainty under Trump (Priority: 5/5): Trade policy uncertainty is described as historically minimal for decades, then sharply rising under Trump, becoming a major component of overall policy uncertainty and affecting business decisions. Survey evidence from the Atlanta Fed and Bank of England (Priority: 4/5): Bloom describes firm surveys that directly ask about uncertainty and find negative effects on investment, especially in manufacturing and construction, offering real-time evidence beyond newspapers. Uncertainty and stock market jumps (Priority: 4/5): A separate research stream uses newspaper explanations of large stock market moves to show increasing clarity over time, with trade becoming a major driver of market jumps under Trump.

Key Arguments: Uncertainty matters because it raises the value of waiting, leading firms and households to postpone investment and consumption. Two main mechanisms operate: risk aversion (higher perceived cost of capital, more saving) and real options (delaying decisions). The empirical relationship between uncertainty and weaker growth is very strong, especially for investment, but causality runs both ways. Historical and contemporary newspaper-based measures provide a useful proxy for uncertainty, even if they are imperfect. Trade policy uncertainty was negligible for decades but surged sharply with Trump-era trade conflicts, making it a major policy issue. Direct firm surveys suggest trade uncertainty reduces investment and GDP, with especially negative effects in manufacturing and construction. Trade uncertainty may be less qualitatively unique than other forms of uncertainty; for firms, uncertainty in general is harmful regardless of source.

Data Points: Trade uncertainty share of EPU coverage: 20–30% of articles - Bloom says trade now accounts for a large share of policy uncertainty coverage, versus about 1% five to ten years earlier. Earlier trade uncertainty share: ~1% - Past trade-policy uncertainty was a tiny part of overall economic policy uncertainty before the Trump era. GDP impact from trade uncertainty surveys: 0.2–0.3% of GDP - Atlanta Fed survey work estimates a material but not recessionary drag on U.S. output. Investment impact from trade uncertainty surveys: About 1% - Survey results suggest trade uncertainty cut firm investment by roughly 1%. Large stock market jumps analyzed: 1,200 U.S. jumps since 1900 - Bloom’s study uses newspaper explanations for big market moves over a long historical sample. Other-country stock market jumps analyzed: About 2,000 - The same methodology was extended to other countries. Definition of a stock market jump: More than 2.5% up or down - Used to identify major market moves in the stock-market attribution study. Drivers of stock market jumps: macro news: About 25% - Inflation, payrolls, and other macro releases explain roughly a quarter of major jumps. Drivers of stock market jumps: company earnings: About 20% - Corporate earnings announcements account for about one-fifth of jumps. Drivers of stock market jumps: unknown: About 15% - In many cases, newspapers still cannot identify why the market moved. Trade as a driver of stock market jumps pre-2017: 0 jumps from 1940–2017 - Trade was not attributed as the cause of any jumps for decades before the Trump era. Trade as a driver of stock market jumps under Trump: 40% of jumps - From 2017 onward, trade was tied to a large share of major market moves. Trade-related market jumps in the last year: More than half - Bloom says trade accounted for over half of jumps in the most recent year discussed. Positive vs. negative policy jumps: Policy news is almost 2x more likely to explain positive jumps - Because good news is often publicized while bad news is leaked slowly.

Pivotal Quotes: "The main way we think uncertainty matters is it leads firms and consumers to pause what they're doing." — Nick Bloom: Explaining the core theory of uncertainty and its effect on investment and spending. "Trade policy uncertainty is what is in some ways graphically the most amazing index because it's like a dead topic." — Nick Bloom: Describing the long historical quiet and dramatic recent surge in trade-policy uncertainty. "I actually don't think that trade uncertainty is particularly different from other types of uncertainty." — Nick Bloom: Answering whether trade policy uncertainty is special relative to other policy risks.

Implications: For businesses, uncertainty—especially around trade—can meaningfully delay investment, hiring, and spending. For policymakers, it means rhetoric and policy shocks can have real macroeconomic costs even before tariffs or laws fully bite.