110 100  9  8  120  60 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20  Quarters since GDP peak  Source: ONS and Bank calculations. The Monetary Policy Committee’s May forecast incorporates some of these uncertainty effects. Our projection for the global economy was for 2016 growth of just 3%, the slowest pace since 2009. Domestically, we expected growth to slow to 2% in 2016, partly as a consequence of an increasing drag from uncertainty. Specifically, in May the Monetary Policy Committee (MPC) estimated that the pick-up in UK economic uncertainty it had recently seen would lower our GDP by around 0.7% after a year. While material, this was less than suggested by past relationships partly because our projections were conditioned, by convention, on a vote to remain in the EU, suggesting uncertainty would fade smartly after the referendum. Even before 23rd June, we observed the growing influence of uncertainty on major economic decisions. Commercial real estate transactions had been cut in half since their peak last year. Residential real estate activity had slowed sharply. Car purchases had gone into reverse. And business investment had fallen for the past two quarters measured. Given otherwise accommodative financial conditions and a solid domestic outlook, it appeared likely that uncertainty related to the referendum played an important role in this deceleration. It now seems plausible that uncertainty could remain elevated for some time, with a more persistent drag on activity than we had previously projected.
This point is not trivial. Research has shown that people who have experienced low returns throughout their lives, like the “Depression Babies” of the 1930s, report lower willingness to take financial risk, are less likely to participate in the stock market, invest a lower fraction of their assets in equities, and are more pessimistic about future returns.8 Today, uncertainty has meant an inchoate sense of economic insecurity for many people despite generalised economic prosperity. Across the advanced economies, employment appears less secure, wages more subdued, and inequality more pronounced. And its precautionary effects can mean spending is deferred because there is often a real option value to waiting.9 Firms delay investment decisions. Investors seek safe returns. Households put off buying durables. The common thread is that any economic decision that requires finance, has a sunk cost, or an uncertain payoff, is affected. While the effect on output is clearly negative, the effect on inflation is ambiguous. Uncertainty’s stultifying effects weigh on employment and aggregate demand, creating disinflationary pressures, while the freeze in resource reallocation can hold back productivity and aggregate supply, creating inflationary pressures.10 11 Higher uncertainty can also mean investment responds more sluggishly to demand stimulus.12  7  See Broadbent (2014) for a further discussion of disaster risk and what it means for safe rates. Broadbent, B (2014), “Monetary policy, asset prices and distribution”, Bank of England. See also Barro, R (2009), “Rare disasters, asset prices, and welfare costs”, American Economic Review, 99(1).