How uncertainty can slow down the Dutch economy

We live in an uncertain world

Uncertainty is like corrosion in the engine of our economy: it makes businesses and consumers reluctant to invest and spend. Uncertainty is currently exceptionally elevated, mainly driven by the unpredictability of US government trade policies and rising geopolitical tensions. The trade war is producing a shock, with economic and financial consequencesthat are difficult to predict at present.

The trade tensions follow a series of major disruptions to the global economy, including the COVID-19 pandemic and the war in Ukraine. Each of these shocks has triggered repeated spikes in uncertainty in recent years. Over the past five years, these different forms of uncertainty have frequently surged together. Examples include geopolitical, economic or financial uncertainty.

Uncertainty now at historically high levels

Uncertainty is difficult to measure because it is an abstract and often elusive factor that takes on different forms. Nevertheless, in a new analysis , we have endeavoured to gain a better understanding by combining different measures of uncertainty (see Figure 1).

Figure 1 - Global uncertainty measures and composite index

Source: DNB calculations. Note: the figure shows an index of uncertainty composed of the EPU, VIX and GPR indices, see Baker et al. (2016) and Caldara and Iacoviello (2019).

Uncertainty measures indicate how often uncertainty about economic policy, trade and geopolitical developments is reported in the media. Uncertainty in financial markets is gauged in a different way, through stock market volatility. Figure 1 shows that the number of articles on uncertainty has increased over the past decade and has risen particularly sharply recently. At present, trade policy uncertainty is the most prominent. 

Significant effects on the Dutch economy

Uncertainty affects the economy in several ways. It harms sentiment and confidence in the economic outlook. Faced with an unpredictable policy environment, households may become more cautious and delay spending or increase precautionary savings. Firms may delay or scale back investments due to pessimism or concern about future sales. Trade relations also play a role. For instance, uncertainty about import tariffs can disrupt global trade flows by raising production costs and limiting access to foreign markets.

This analysisshows that uncertainty shocks in the Netherlands lead to rapid declines across a range of key economic indicators (Figure 2). Within just a few months after an uncertainty shock, economic sentiment falls by 2.3% and industrial confidence by 1.6%. These shocks also lead to a 0.4% decrease in investment (compared to the long-term average annual growth rate of 2%) and a 0.6% reduction in industrial production (the long-term average annual growth rate is 1%).

Figure 2 - Effects of uncertainty on the Dutch economy

Source: DNB calculations.

Note: the figure shows the estimated maximum impact on key Dutch economic indicators following a 1 standard deviation increase in total uncertainty, based on a Dutch media-based index (Financieele Dagblad) and estimated using a Bayesian VAR model over the period 2005–2025. The y axis shows percentage changes.

In this analysis, we also use specific measures of uncertainty in the Netherlands, based on news coverage in the Dutch daily Het Financieele Dagblad.

Similar effects, but lower in magnitude, are found in the part of the analysis that focuses on the economic effects of climate policy uncertainty, which has also risen substantially recently.

Resilient financial sector important to limit impact of uncertainty

Besides the impact on the economy, elevated uncertainty can also affect financial stability. Our analysis finds that elevated uncertainty comes with a higher probability of corrections in equity prices, corporate bonds and bank bonds. We have indeed seen evidence of this in global financial markets since the onset of trade tensions, especially in early April. Through this financial channel, an uncertainty shock can increase risk premiums and thus tighten overall financial conditions. Heightened risk aversion among banks may reduce the availability of credit for firms and households, thus damaging economic activity.

A well-capitalised banking sector helps to dampen the economic and financial stability risks that accompany heightened uncertainty. Estimates for the Netherlands and other advanced economies show that higher bank capital ratios diminish the risk of a deep recession. Our calculations show that a 1 standard deviation (equal to 0.7 percentage points) increase in the capital ratio of banks supports economic growth during recessions by more than 0.3 percentage points, compared to less than 0.1 percentage points in normal times.

Figure 3 - Effect of an increase in bank capital on economic growth in the Netherlands, during normal times and recessions

Source: DNB calculations. Note: The figure shows the estimated effect of a 1 standard deviation increase of bank capital on GDP growth and the 90% confidence intervals, based on a quantile regression, where the year-on-year GDP growth is the dependent variable. The model includes as explanatory variables the previous year’s GDP growth, the index of composite uncertainty from Figure 1, and the Tier 1 capital ratio of the Dutch banking sector (both one period lagged). ‘Normal times’ is the effect on median GDP growth, and ‘during recessions’ is the effect on the 10% lowest growth outcomes (i.e. the 10th percentile of the GDP growth distribution).

The increase in bank capital ratios over the past decade has thus helped reduce risks to the Dutch economy. A well-capitalised banking sector also reduces the impact of uncertainty during major economic shocks. In other words, this softens the blow of uncertainty for the economy, thus underscoring the importance of maintaining capital requirements in times of heightened uncertainty to ensure a financial sector that is resilient to potential shocks triggered by uncertainty.

This has already been demonstrated in practice. Recent major shocks such as the COVID-19 pandemic have not caused problems in the financial sector. Indeed, the financial sector has been able to absorb these shocks. The strengthening of global financial legislation and regulations following the financial crisis has been an instrumental factor in this regard. We are seeing increasing pressure not only on the global trading system, but also on the global system of rules in place to boost the stability and security of the financial sector. Maintaining the resilience of financial institutions remains of paramount importance.

Multilateralism and a strong Europe

Making the Dutch economy more resilient to uncertainties requires cooperation between countries. The current uncertainty is mainly driven by international trade conflicts and geopolitical tensions, which the Netherlands cannot easily resolve on its own. It is therefore essential that we remain committed to international cooperation, a strong Europe and well-functioning multilateral forums. Being an open economy, the Netherlands only stands to benefit from this. We will discuss this in greater detail in the Financial Stability Report, which will be published on 20 May.