Volatility and Reforms: The Overlooked Virtues of Economic Uncertainty

Lambert here: [whistles] “Always look on the bright side of life…”

By Alessandra Bonfiglioli, Assistant Professor, Universitat Pompeu Fabra, Affiliated Professor, Barcelona Graduate School of Economics, and CEPR Research Affiliate, and Gino Gancia, Senior Researcher, CREI (Barcelona); Adjunct Professor, Universitat Pompeu Fabra; and CEPR Research Fellow. Originally published at VoxEU.

Does economic uncertainty promote or impede the adoption of structural reforms? This question arises when jointly considering two issues that became particularly relevant during the Great Recession.  On the one hand, the rise in macroeconomic volatility in recent years has stimulated a new literature on how uncertainty impacts economic activities and private investment decisions (see Bloom 2009, 2011, 2011a, 2014). On the other hand, the Crisis has also revealed the need for structural reforms. Surprisingly, little effort has been devoted to studying the effect of uncertainty on public policy decisions such as reforms.  In a recent paper, we aim to fill this gap by empirically investigating whether and how economic uncertainty affects the implementation of structural reforms (Bonfiglioli and Gancia 2015).

What Does the Theory Predict?

While the political economy literature has identified a series of factors fostering or hindering the adoption of reforms, little attention has been paid to the role of uncertainty.  Some theories suggest that uncertainty on the distributional effects of a reform may be an obstacle to its adoption, for instance because it may induce a status quo bias in voters (Fernandez and Rodrik 1991), or a war of attrition between parties resulting in inefficient delays (Alesina and Drazen 1991). Alternatively, as we have earlier suggested (Bonfiglioli and Gancia 2011, 2013), uncertainty on economic outcomes may promote the adoption of reforms by making re-election probability depend more on luck and less on policy action – thereby leaving governments more free to adopt reforms with short-run costs and long-run benefits.

Measuring Reforms and Economic Uncertainty

For our empirical analysis, we rely on two recent datasets providing useful information for measuring structural reforms and economic uncertainty. For structural reforms, we borrow from the IMF (see Ostry et al 2009) a set of regulation indices covering six sectors – the domestic financial market and external capital account, trade and the current account, product markets and agriculture. We normalise all indices between 0 and 1, with a higher value corresponding to a greater degree of liberalisation, and measure structural reforms for each sector as the annual change in its index.

Our measure of economic uncertainty, drawn from a recent contribution by Baker and Bloom (2013), is the standard deviation of daily stock market returns, which reflects the variability in investors’ expectations over the future sales of firms, computed from the Global Financial Database.

We conduct our analysis on a sample of 56 developed, emerging, and developing countries, with annual observations between 1973 and 2006, and data on structural reforms in six sectors, corresponding to about 6,400 sector-country-year observations.

Empirical Strategy and Results

We regress our measure of structural reforms on a set of variables including one-year lags of stock market volatility, the liberalisation index, and, progressively, political variables, real and financial crises, and development indicators. We also include country-sector and year fixed effects to account for omitted heterogeneity.

The OLS coefficient estimates suggest that structural reforms are strongly and positively correlated with economic uncertainty. However, although volatility enters in the regression with one lag, these estimates may not capture a causal link from uncertainty to reforms. For example, volatility in the year prior to the adoption of reforms may be affected by the political debate over the design and approval of the reform itself, which would induce reverse causality. To identify the causal effect of volatility, we instrument it in three alternative ways and estimate our specifications with two-stage least squares.

First, we argue that, given the degree of international integration of stock markets and the importance of world-level shocks, there are some common factors driving volatility in all countries. Such a world component of volatility seems a good instrument for country-specific volatility because it is likely to be independent of the political debate over reforms taking place in each single country. Hence, our first instrument is the lag of the average volatility in the other sample-countries, weighted by their real GDP per capita. The results prove our instrument to be strong and suggest that uncertainty indeed positively affects structural reforms.

As an alternative set of instruments for stock market volatility, we borrow from Baker and Bloom (2013) four indicators capturing exogenous events such as natural disasters, political shocks, and terroristic attacks. All indicators are constructed as dummies accounting for the occurrence of at least one shock in a given country and year, weighted by a measure of the attention devoted by world media to the country around the day of the shock.  Moreover, since political shocks and terroristic attacks may be endogenous to economic and political conditions (such as reforms) in a country, we also use, as a third set of instruments, the average shocks that occurred in other sample countries, weighted by real GDP per capita. The results show both sets of instruments to be strong and confirm that uncertainty promotes reforms. In particular, the IV coefficients suggest that a one-standard deviation increase in volatility has a positive effect corresponding to 16-30% of the average reform size.

As a further robustness check, we show that of our findings are preserved when replicating the analysis restricting the sample to some groups of reforms and countries.

Besides providing novel results on the effects of uncertainty, our estimates corroborate the existing evidence that reforms are also positively correlated with the degree of democracy, left-wing orientation of governments and presidential systems. Our analysis also suggest that both recessions and financial (banking, currency, and sovereign debt) crises are associated with a lower reform effort.

As a final exercise, we take a step towards understanding the mechanism linking uncertainty to reform intensity. Our starting point is the model in Bonfiglioli and Gancia (2013), where uncertainty can mitigate political myopia generated by electoral incentives and asymmetric information. The argument is that in times of turmoil re-election depends more on luck rather than political actions, thereby leaving the government freer to invest in reforms with short-run costs and future payoffs. We then test the prediction that uncertainty promotes reforms more where fewer voters are informed about policy choices. To do so, we estimate our main specifications on two groups of countries, characterised by high and low circulation of daily newspapers per thousand inhabitants in 1996. Consistent with the theory, the results point to larger effects in the latter group of countries.


Our analysis has unveiled a strong positive effect of uncertainty on the intensity of structural reforms, which seems to be more pronounced in countries with poorer information about policy action. These results are important in at least two respects. First, they suggest that times of market turmoil, which are characterised by a high degree of uncertainty, may provide an opportunity to implement reforms that would otherwise not pass. Second, if the myopic bias is indeed driven by poor information, as hinted by our last findings, it would imply that promoting transparency, guaranteeing media independence, and educating voters are important factors to make democracies work well.


Alesina, A and A Drazen (1991) “Why are stabilizations delayed?”, American Economic Review, 81: 1170-1188.

Baker, S and N Bloom (2013) “Does uncertainty drive business cycles? Using disasters as natural experiments”, NBER Working Paper 19475.

Bloom, N (2009) “The impact of uncertainty shocks”, Econometrica, 77(3): 623–685.

Bloom, N (2011) “The uncertainty shock from the debt disaster will cause a double-dip recession” VoxEU.org, 22 August.

Bloom, N (2011a) “The price of market uncertainty is a double-dip recession,” VoxEU.org, 26 August.

Bloom, N (2014) “Fluctuations in uncertainty”, Journal of Economic Perspectives, 28(2): 153–176.

Bonfiglioli, A and G Gancia (2011) “Why are reforms so politically difficult?“, VoxEU.org, 14 June.

Bonfiglioli, A and G Gancia (2013) “Uncertainty, electoral incentives and political myopia”, The Economic Journal, 123(May): 373–400.

Bonfiglioli, A and G Gancia (2015) “Economic uncertainty and structural reforms”, CEPR, Discussion Paper 10937.

Fernandez, R and D Rodrik (1991) “Resistance to reform: Status quo bias in the presence of individual-specific uncertainty”, American Economic Review, 81(5): 1146-1155.

Ostry, J D, A Prati, and A Spilimbergo (2009) Structural reforms and economic performance in advanced and developing countries, International Monetary Fund, Washington, DC.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. sd

    Second, if the myopic bias is indeed driven by poor information, as hinted by our last findings, it would imply that promoting transparency, guaranteeing media independence, and educating voters are important factors to make democracies work well.

    And the inverse? Namely that obstructing transparency, controlling what the media reports, and an uneducated populace make for poor democracies which clearly serves a narrow group of interests in opposition to democracy. L’etat c’est moi and all that.

    1. tony

      Never let a crisis go to waste. I’d like to know if these IMF structural reforms have ever had a positive effect on the general population.

      1. jfleni

        Almost certainly not!

        “Never let a crisis go to waste” … Only when the plutocrats are grasping in panic for capital gains and stock buy-backs can regular folks have any gains at all!

        The powers-that-be will act to save their system first and a pox on the plutocrats.

  2. Steve H.

    Well-juxtaposed with yesterdays ‘Predictability of Political Extremism’.

    Still mulling the implications…

  3. Synoia

    it appears to be a very long winded analysis of what Bookies already know and do. In addition Bookies actually can place probabilities, hard numbers, on outcomes.

    I recommend this economist spend time at the races, observes uncertainty at work, and contemplates the mechanisms of evaluating uncertainty.

    1. Jim Haygood

      ‘the standard deviation of daily stock market returns … reflects the variability in investors’ expectations over the future sales of firms’

      It’s earnings and dividends, not sales, that investors discount to determine the present value of shares.

      But the discount rate also varies, based on central bank policy and expected inflation.

      So the author correctly concludes, ‘these estimates may not capture a causal link from uncertainty to reforms.’

      NED: nihil erat demonstrandum

      1. craazyman

        This post will not be going into the NC Hall of Fame, that’s for sure.

        This is like those movies they’d show on the overnight UHF channel, movies you’d never heard of, ever. It would be something like “The Brenda Affair” and their’d be a one-liner description in the TV guide, something like “Don’t let her keep you up.” Even as a kid they’d crack me up, the one-liners from the movie critic copywriters. They had one sentence to show their stuff, to condense both the movie and their review in an inch-wide line of 8 poiint type. Some of them did!

  4. TheCatSaid

    Volatility for who? (Would the degree of uncertainty experienced by the precariat be accurately reflected in the stock market?)

    Reforms benefitting who? (As another commenter observed, “reforms” can be snuck in where there is poor transparency–what qualifies as a “reform”?)

  5. James McFadden

    Quote from article: “they suggest that times of market turmoil, which are characterised by a high degree of uncertainty, may provide an opportunity to implement reforms that would otherwise not pass.”
    Let’s see, where have I heard that idea before?
    Oh yea – Naomi Klein’s Shock Doctrine.

    I agree with Craazzyman – a pretty bad post. The author makes sure the reader knows she can normalize numbers, perform standard deviations, regression, correlations, and least squares fits – all the stuff one learns in high school math — or playing with an excel spreadsheet. Sounds like an assistant prof trying to impress the associate profs with jargon.

    This seems to be one of those typical economic simplifications of a complex problem where one argues cause and effect from a correlation, supported by some plausibility argument, to get a result we already know (in this case stolen from Klein). You can always find correlations – and nearly all are meaningless. Since herd behavior is inherently chaotic, and since correlations don’t demonstrate cause and effect, I’d say this result is pretty useless. The argument involving “reform intensity” tied to “informed voters” is also pretty nonsensical in a world where the press is controlled by an oligarchy and the public doesn’t understand anything about the reforms enacted – if they did they’d be in the streets with pitchforks and torches.

    This article adds nothing to what Klein already noticed – that politicians frighten us during crises in order to implement policies we would never except under normal circumstances. But since we are uninformed sheeple, we continue to be conned and frightened by crooked politicians and their corporate backers.

  6. Wade Riddick

    Consider that technological change is one important variable and also consider that volatility may change the funding model of politics (see Tom Ferguson’s work from MIT). With volatility causing turmoil in various industries, politicians – especially incumbents – may need to cast a wider net for financial support.

    As fossil fuels are replaced by solar (and possibly, soon, cold fusion reactors – you guys should really cover the recent Capitol Hill briefing on the subject by Brillouin Energy), the volatility may produce a sudden burst of reforms the likes of which we haven’t seen in the energy sector since oil/cars took over from coal/rail. This period encompassed everything from the Model T to World War II and the Tennessee Valley Authority. Solar’s getting very efficient very quickly and the only thing the petroeconomy has working for it is the enormous sunk costs, soon to be stranded costs. That kind of collapse will generate plenty of volatility.

      1. AlainCo (@alain_co)

        It seems you are misinfrmed.

        The phenomenon is reproduced, and for example He4/heat corelation observed let no doubt of a nuclear phenomenon
        I advise you to consult the refereed paper of this special issue on LENR.

        Tom Darden of Cherokee fund have investin more than 10M$, and Woodford fund have invested 50M$ https://woodfordfunds.com/focus-on-long-term/#comment-6294 http://fortune.com/2015/09/27/ceo-cherokee-investment-partners-low-energy-nuclear-reaction/

        Tom Darden have agreement with Baishishan Technology Park on that subject
        Elforsk the Swedish DoE/EPRI funded some tests and reports.

        Japan is funding under NEDO program works involving Toyota, MHI and Nissan

        There is others minor moves, but Note that Navy NR replicates Italian ENEA and SRI works.

        you hypothesis is a risky bet.

        1. James McFadden


          I’m a physicist and looked into cold fusion as a postdoc in the late 80s when cold fusion hit the headlines – as many physicists did. The bottom line is that chemistry can’t produce enough overlap of the nuclei wave functions to induce fusion – or in layman’s terms, chemistry can’t produce high enough pressures to localize the nuclei to create fusion. In addition, no neutrons – no fusion.

          Cold fusion is definitely nonsense – much like the house-sized comets bombarding the earth at 20/minute published by Lou Frank. Publication in a scientific journal doesn’t mean it’s correct – just that it got past two referees.

          The chemistry is interesting – it fooled Pons and Fleischmann – a bit embarrassing for the scientists — but scientists can often be fooled — at least for a while.

          On the other hand, LENR is an investor scam, and from a brief scan of the internet, AlainCo seems to be part of that scam.

          For any others that are considering investing in cold fusion, you might first want to consider the words of P.T. Barnum.

  7. Wade Riddick

    If they are scams, then why does MIT have a professor teaching the subject and demonstrating the phenomenon in his classroom? Why do NASA, the US Naval Labs (Louis F. DeChiaro) and others have researchers working in this field? Why has the Nobel Laureate Josephson said this is a real phenomenon? Why have Toshiba, Mitsubishi, Airbus, ST Microelectronics and others all filed and received patents in this area?

    Hey, I have an idea. Since you’re such an expert on fraud, why don’t you buy stock in these public companies and then sue them for defrauding their investors?

    Like the people who believe global warming is a hoax, I presume you’ll be able to prove your case in court… (By the way, ever programmed a climate model in an actual computer before having an opinion on the subject? I have. It’s hard to do and, in no way, can I offer any improvements on it. I’m just an English major who went to graduate school and studied the history of technological development in this country.)

    Personally, I think I’ll trust the independent third party Lugano report on Rossi’s E-cat reactor and the independent third party report on Brillouin Energy. Without fusion, it’s kind of hard to explain why excess heat is occurring in the E-cat and why different isotopes are coming out than went into the reactor. That’s kind of the essence of fusion. Since a U.S. agency is reported to have bought an E-cat back in 2011, maybe you can file a Qui Tam suit against the government over it?

    For those of you with some doubt about it, you can replicate the Celani wire experiment with a local high school class and demonstrate excess heat. You can also replicate one of several open-source efforts. They’re not reporting COPs of 10 or 20+, but 3 is not bad.

    Why has Oilprice.com, Wired UK and Forbes covered the subject?

    These are not activities that had the previous hallmarks of fraud all over them. These engineers are not raising money from public investors, they are not doing anything that can’t be replicated by third parties in a lab, nobody’s been able to show a hoax at work and crucially, unlike the hot fusion researchers without calorimetry expertise who claimed to debunk the topic, the cold fusion guys don’t have expensive, fancy government contracts at risk.

    As Planck said, science advances one funeral at a time…

    Whether through competition with solar power or cold fusion, the price of electricity is going to drop 60-90+% over the next twenty years and when oil goes down for the count, the Republican Party and much of the Democratic will lose a very major funder of their political operations. The market will become highly volatile (prices are already falling so rapidly in solar, I believe Jim Chanos has made money shorting their Yieldco financing vehicles). As those prices drop, the iron clad grip of the old energy economy on government will loosen. Not only will autism rates and clogged arteries drop as mercury emissions from coal-fired power plants flag, but so too will the political system unclog, however temporarily, and a window for reform will open before the next generation of oligarchs get organized. It’s rare. It happens once a generation with transitions in technological regimes but it does happen *with regularity*.

    1. James McFadden

      Not sure which of these quotes best applies to Wade Riddick’s comment.

      “A flow of words is a sure sign of duplicity.” Balzac
      “Better to remain silent and be thought a fool than to speak out and remove all doubt.” Twain
      “Insanity: doing the same thing over and over again and expecting different results.” Einstein
      “One of the symptoms of an approaching nervous breakdown is the belief that one’s work is terribly important.” Russell

  8. Wade Riddick

    This isn’t my work that’s so important that you’re criticizing. It’s the work of plenty of other people. Go have your argument with Josephson or any of the many other scientists who have evaluated the phenomenon and concluded it’s real. And if you’re such an expert in fraud and science, go buy some shares and file a lawsuit against some of these publicly traded companies. You don’t simply assert your own personal opinions and then call that science. Go tell us how the fraud works. Prove your case.

    Nobel prize-winning physicist Brian Josephson says cold fusion “may well be the most important technological advance of the century.”

    Dennis Bushnell, chief scientist at NASA’s Langley Research Center, called it “capable of, by itself, completely changing geo-economics, geo-politics, and solving climate issues.”

    Jean-Francois Geneste of Airbus Group recently delivered a paper entitled, “LENR — From Experiment to Theory” at a conference that was hosted by Airbus in Toulouse, France. Did he lie? How did he lie? Why? What are the fraud flags on all this?, as Bill Black asks at Certified Fraud Examiner conferences.

    I’m not one to argue that scientists never have any conflict of interest or incentive to lie. Medicine is rife with all sorts of false claims like sugar doesn’t cause diabetes or deworming the gut is safe. But you can prove all of these things wrong both with gross epidemiology (e.g., populations that have never been dewormed never get multiple sclerosis) and with specific gene arrays that show how perturbed cellular signaling becomes in specific experiments (worms are neuroprotective).

    When every independent scientist who looks at these reactors walks away saying they work and somehow the reactors are adding mass to the nucleus even though they don’t know exactly how, that tells me something from a fraud point of view – namely, that there’s not likely to be one. Do you know another process that increases atomic number in a nucleus besides, you know, fusion?

    You think there’s a fraud here? Find a cause of action and go file a lawsuit. I know there’s plenty of fraud in the mortgage markets *because there are plenty of lawsuits*. One of them was filed by a clerk of court down the street against MERS.

  9. James McFadden

    Too bad about Josephson – he did good work in his 20s. He seems to have gone off the deep end as he grew older. Senility comes early for some. When someone says “most important technological advance of the century” that should raise lots of red flags – see my Russell quote.

    For most of the other “scientists” working in this field, I would say the following Upton Sinclair quote applies. “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

    However, I sort of like this quote from The Pathoskeptic.

    “cold fusion/LENR seems the be the science of confused old men. Followed by blind mice. Not to forget the ones who try to take advantage of the confusion.”

    Just out of curiosity – are you one of those sucker investors who sunk money into this scam – or are you one of the confidence men?
    AlainCo appears to be one of the confidence men.

    Knock yourself out on this one – I did my homework years ago and have no interest in chasing these hucksters.

    1. Mary Yugo

      James McFadden is not a physicist – he is a shill working for JTRIG an undercover troll op run out of the UK. I know all about cold fusion and even though it is a reproducible phenomenon (the deposition type) my job pretend physicists like James only make things worse for honest skeptopaths!

  10. Wade Riddick

    I have no money at stake in cold fusion but plenty of their detractors have tremendous conflicts of interest and you do, yourself, seem to be suffering from some confusion about how to 1) detect fraud and 2) what to do about it.

    If you think Airbus is defrauding its shareholders – or Toyota or Mitsubishi or Toshiba or STMicroelectronics, for that matter – then sue them.

    NASA is a public agency receiving public money. Why don’t you join the global warming conspiracy theorists and file a Qui Tam suit. Or are you completely unable to understand actionable fraud?

    In such a suit, you will be asked to explain how several isotopes inside the E-cat reactor increased in number. The independent auditors from Lugano had no explanation other than some nuclear process. That’s basic fact and evidence. Did Lugano participate in the fraud?

    This is a website dedicated to fraud. It’s not just about people making true claims about fraud. It’s also about people making false claims of fraud – like the budget austerians, who claim that government spending is per se oppressive of the rights of man. They claim black people voting is fraudulent and we need ballot security. (No. Black people are taxpayers and when they’re not allowed to vote, you need to refund all the taxes they paid because that’s basic democratic theory – a part about the original Tea Party principle the Koch brothers can’t understand. No taxation without representation.)

    During a transition from one technological regime to another many false claims are made. Many old illusions about the old regime are shattered. This is basic Thomas S. Kuhn _Structure of Scientific Revolution_ stuff. Much of the practice of science in complex fields pertains less to evidence and argument and more to socialization.

    I have reasoned on the basis of evidence in our little exchange here. You have consistently reasoned on the basis of authorities you are sure would never lie to you. I have never believed authority without proof. I just don’t. If everything they say is true, go sue all these public companies. You’ll be rich. What are you doing sitting here arguing with me?

    By the way, the university system employing Bill Black has some of the leading researchers in this field. Why don’t you ask him to go over there and check them out?

    Why is it so difficult to accept that in an era where we’ve shrunk particle accelerators down to a desktop size using relativistic effects and we’ve violated quantum temporal loops to create light amplifying circuits that something strange might be going on at the quantum level that generates a little excess heat? Why is there such anger and rage at this subject in particular? These are not rational responses.

    Everybody’s wrong about something at some point in life. When confronted by new evidence, rational men change their minds.

    Would you like me to take you, a total stranger, at your word without any evidence of how the fraud occurs or should I instead believe the US Naval Sea Systems Command (NAVSEA) presentation on LENR given at an IEEE Meeting on “LENR Phenomena and Potential Applications” (Sept. 23 2015 at Teradyne in North Reading, Massachusetts)? View the slideshow at .

    1. James McFadden

      I think you should take your meds, try to calm down, and ponder the quote by Bertrand Russell. “One of the symptoms of an approaching nervous breakdown is the belief that one’s work is terribly important.”

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