The ongoing government shutdown in Washington has some commentators worried about its impact on markets and the economy. Others are less concerned. Whatever your view, the shutdown is a particularly nasty but now-familiar consequence of divided government in the United States, and the larger question is how that situation has historically affected economic uncertainty. The answer matters, particularly as fears of a recession are on the rise, as economic uncertainty has been shown to sap business investment, output, and job growth. One longtime argument —from both academics and investors like Ken Fisher — is that divided government usually reduces economic uncertainty in the short run by imparting a status quo bias to public policy. The counterpoint is that divided government is increasingly a symptom of the country’s extreme political polarization and has paralyzed government, ostensibly causing some economic jitters.
So, how much have political polarization and divided government actually contributed to economic uncertainty? According to our analysis, probably not much. Gridlock certainly may be spooking financial markets, but the impact of political divisions on the U.S. macroeconomy in general is another matter. In the United States, neither political polarization nor divided government has been strongly correlated with economic uncertainty, broadly defined.
Our analysis takes a holistic view of economic uncertainty, and it is based on a widely-cited index that aggregates the volume of news about economic policy uncertainty, the number of set-to-expire provisions in the federal tax code, and the variability of U.S. macroeconomic forecasts. In what follows, government is considered divided whenever the president’s party differs from that of either the House or Senate majority, which we coded annually based on official numbers.
The chart below cuts against the idea that divided government coincides with periods of heightened economic policy uncertainty. Since 1985, average uncertainty appears no higher in years of divided government than in years when the president’s party controls both houses of Congress. Instead, the story is that economic uncertainty peaked during recessions and the global financial crisis, and following Trump’s surprise victory in November, 2016; it was lowest around the dot-com boom and Bush tax cuts.
We can also look at political polarization, as measured by the Philadelphia Fed’s monthly Partisan Conflict Index. At first glance, that series appears to move in lockstep with the Economic Policy Uncertainty Index, but the correlation between the two before the global financial crisis was actually a statistically insignificant 0.23. After the crisis, the correlation weakened to a mere -0.06—essentially zero.
All of this suggests that narratives about partisan squabbling amplifying policy uncertainty should be taken with a grain of salt. Yes, financial markets have noticed recent failures to govern, and government shutdowns have adverse economic effects in the short term. But, if history is any guide, the longer-term rise in political polarization and recent return to a divided government in the U.S. does not necessarily portend more economic uncertainty going forward.