How can increased uncertainty affect the economy?

Most studies show that increased uncertainty has negative effects on the real economy, and that the effects are greater when the economy is weak. If the high level of uncertainty is prolonged, the economic impact could also be significantly higher. However, the studies also show that if the uncertainty were to quickly decline, the negative impact on the economy could be both small and short-lived.

The effects on inflation are more uncertain. Most studies show that increased uncertainty leads to lower inflation as a result of lower demand in the economy. At the same time, some types of uncertainty, such as geopolitical turmoil or trade conflicts, can create supply shocks, via supply chains for example, which can instead drive up prices. The impact on inflation therefore depends on whether the uncertainty mainly affects demand or supply. In a small open economy, the effect on the exchange rate is also important.