Definition of regime uncertainty
Regime uncertainty refers to the pervasive uncertainty that investors face over the security of their property rights and the income it yields. It was pioneered by Robert Higgs as an explanation for the duration of the Great Depression - he argued that Roosevelt’s policies led to a significant reduction in investors’ confidence regarding the durability of the capitalist system, causing private investment (and thus economic output) to remain below potential. In short, people hold off on long-term decisions when there is uncertainty over the rules of the game.
Most economists acknowledge that confidence plays an important factor in determining investment, but the fact it is hard to quantify poses problems. People should be wary of policymakers that promise to increase confidence, since managing expectations is a complex, difficult task. Regime uncertainty puts meat on the bones of “animal spirits”, suggesting that a clear and credible commitment to the security of property rights is crucial during a downturn.
There is evidence of regime uncertainty during the recent financial crisis. When governments bailed out banks they provided temporary respite but severely undermined the stability of property rights. Investors were faced with a double burden of not only having to recalculate their potential returns in light of new economic conditions, but they also had to factor in potential government interventions. Policy can therefore have the unintended consequence of delaying the economic recovery.