The Optimal Economic Uncertainty Index: A Grid Search Application

A noteworthy characteristic of empirical studies on the economic uncertainty index is that very few published papers depend on normative analysis. Therefore, normative analysis cannot be used to refute the precision of the economic uncertainty index; the lack of precision is simply the outcome of a misspecification of a commonly used model and a complex data collection process. To overcome this shortcoming, this paper uses the optimal form of the economic uncertainty index and determines its empirical validity based on a sample of 7 countries, including 3 developed and 4 developing countries. Using a grid search optimization procedure, the findings provide some policy implications; the optimal economic uncertainty index can characterize the uncertainty level of macroeconomic conditions and serve as a guiding policy tool for improving uncertainty levels in macroeconomic conditions. The estimated response function of the optimal economic uncertainty index suggests that the exchange rate, inflation, interest rate and output are useful indicators for central banks’ decision-making and that the optimal index supports the prediction of economic uncertainty. Copyright Springer Science+Business Media New York 2014