Uncertainty can negatively influence a changing financial environment and this can push investors to introduce conservative measures to protect their investments. In simple terms, uncertainty creates a situation where entrepreneurs, and even individuals, cannot predict the future status of the economy.
Possible effects of uncertainty on financial environment
- Delayed investment
Before investing in a project, there are numerous things that are factored in to ensure that the investment will bring in some considerable returns. Among them is the future state of economy since an unstable environment can have a negative impact on the projected returns or even contribute to total collapse of the project. Firms or investors are therefore likely to delay their projects if they are uncertain of the future.
- Less hiring
It is common with firms to hire regularly to replace retired employees, increase manpower or get some specialized skills among other reasons. With economic uncertainty, such establishments are likely to avoid new investments and some of them may even scale down their business. This will reduce the need for additional labor and some firms may even decide to lay off some workers.
- Delayed consumption
By delaying investment and pushing some firms to scale down on production, uncertainty will cause a reduction in supply of consumable products. This will then increase demand resulting to increase in prices of such commodities. The situation will push people to delay consumption and they are likely to avoid luxury products. Purchasing power of consumers may also be affected by stagnant or reduced income.
- Weaker stock markets
A changing financial environment can discourage investors in the financial markets since they cannot clearly project their returns. Some of them may even avoid the local currency to limit fluctuations in the amounts being held in reserve. This can offset normal performance of the financial market and the prices of shares are likely to come down. The same situation can also affect performance of government bonds.
Causes of uncertainty
Political turmoil is among the major causes of uncertainty and this pushes investors to hold on their projects until the situation is resolved. The same situation is also likely to be experienced where there’s heightened tension during an electioneering period. Uncertainty can also be caused by unexpected changes in an economy e.g. when foreign nations make decisions affecting investment or trade in a given country.
There are really no guaranteed ways of measuring uncertainty but there are indicators that can be relied on as warning signs. When firms are not certain of the future, they usually tend to hold on to their cash or cash equivalents. These are figures that can be extracted from their balance sheets. Difference between government spending and projections by economic forecasters can also be taken as an indicator of uncertainty.
Addressing the situation
If the factors creating uncertainty are well addressed, the situation can return to normalcy and this can boost investor confidence. The government can intervene by adjusting the monetary policy to increase money supply and reduce interest rates. However, this should be done in a controlled way to avoid inflation. In some cases, uncertainty can contribute to recession if not addressed in time.
Expected mini boom after successful intervention
Once the confidence of investors is restored, people are likely to witness a mini boom as investors try to implement the projects that had been delayed. This will then create a job market that will provide consumers with additional income. The mini boom will contribute to economic growth and consumer purchasing power will be restored as prices of products come down. Measures should then be put in place to avoid similar occurrences in future.