Policy Uncertainty in the Scandinavian Countries

Abstract

Globalization drives the need to properly understand policy uncertainty and how it affects both the economy in general and business conditions. To systematically investigate the effect of policy uncertainty on small, open economies, we develop a policy uncertainty index based on newspaper content for each of the three Scandinavian countries; Norway, Denmark and Sweden. We show how these indices capture important historical events, both local events such as referendums and certain general elections, but also global events such as financial crises. Our narrative validation provides evidence that the three indices are good measures of policy uncertainty. Further, we compare historical policy uncertainty in the Scandinavian countries to a similar index for the US, before analysing the effect of both local and US policy uncertainty on the Scandinavian economies. Our findings indicate that increased policy uncertainty both at home and in the US leads to economic contraction, a significant decline in stock markets and a long-lasting reduction in the Scandinavian countries’ Purchasing Managers’ Index. These results can be highly relevant for anyone seeking to predict economic indicators in Scandinavia, or other small, open economies. Similarly, our findings can help to better understand how companies react to changes in policy uncertainty.

Keywords: policy uncertainty, economic uncertainty, small open economies

JEL Classification: D80, E22, E66, G18, L50