Policy Uncertainty, Persistence and Growth

Abstract

This paper explores links between policy uncertainty and growth. It provides evidence on the correlation between policy uncertainty and per capita real GDP for 46 developing countries over the 1970-85 period. Cross-section regressions on growth suggest that after accounting for standard variables from the endogenous growth literature, policy uncertainty and growth are correlated. The importance of the correlation and even its sign depend on the particular policy and on the geographical region examined. One channel through which policy uncertainty may affect growth is the investment channel. Using an endogenous growth model where domestic investment is characterized by irreversibilities and policy fluctuates between a high and lowtax regime, we show that the gap between the two regimes and the persistence of a regime jointly determine the pattern of investment and growth. Policy uncertainty in the absence of persistence does not affect long run growth.