Expectation Errors, Uncertainty and Economic Activity

The aim of this study is to analyze the relationship between uncertainty and economic activity. For this purpose, we use a confidential firm level panel data set (Business Tendency Survey) from Turkey to form three uncertainty measures, namely total, idiosyncratic and aggregate uncertainty. In particular, we construct expectation errors of firms by comparing their survey responses about expectations and realizations on their production volume. Our results reveal countercyclical relationships between our uncertainty measures and economic activity. We further show that a one standard deviation increase in aggregate uncertainty is followed by a 0.5 percent decline in year-on-year change of industrial production on impact. The prolonged effect reaches more than 4.7 percent in a year for any of these three measures. In addition to the macroeconomic implications of uncertainty, we exploit the panel dimension of our data set to investigate the effects of firm specific uncertainty on that firm's investment decisions. Ordered probit estimation results show that if a firm makes more expectation errors -faces more uncertainty- it is more likely to defer investment plans even after controlling the aggregate uncertainty