Trade policy uncertainty (TPU) can have significant economic implications, influencing business investments, stock markets, and global trade relationships. To measure this uncertainty, economists developed the Trade Policy Uncertainty (TPU) Index. This index tracks the frequency of trade policy and uncertainty-related terms in major newspapers to assess shifts in trade-related risks.

Historically, the TPU Index has spiked during key events, including the Nixon and Ford trade policy shocks of the 1970s, U.S.-Japan trade tensions in the 1980s, NAFTA negotiations in the 1990s, and most notably, after the 2016 U.S. Presidential Election, when U.S. trade relations with countries like China and Mexico became increasingly volatile.

The TPU Index measures the level of uncertainty or unpredictability in a country’s trade policies at a given time. A high TPU index suggests businesses and investors are unsure about future tariffs, trade agreements, or regulations, impacting their decision-making.

Example: Consider a car manufacturer relying on imported parts. If the government is unclear about potential tariffs on imports, the company may hesitate to make purchases or shift production to a different country, leading to economic slowdowns and supply chain disruptions.

Technical Breakdown of the TPU Index

The TPU Index quantifies trade-related uncertainty by analyzing:

1. Government Announcements & Legal Changes – Tracking modifications in tariffs, trade  agreements, and import/export regulations.
2. Media Coverage & Reports – Examining news articles and official statements to gauge concerns about trade policies.
3. Business Surveys & Market Reactions – Assessing how corporate leaders react to changes in trade policy.
4. To construct the TPU Index, natural language processing (NLP) techniques are applied to newspapers, policy documents, and economic reports to detect trade-related uncertainty patterns.

How to measure the TPU Index

The TPU Index is derived from multiple sources and methods:

1. Text-Based Approaches such as AI scans newspapers, government publications, and business reports to identify uncertainty-related terms. Key sources include The Wall Street Journal, central bank reports, and government press releases.
2. Economic Indicators such as Stock market fluctuations, exchange rate movements, and trade volume changes act as indirect TPU signals.
3. Surveys & Expert Opinions by the Institutions like the IMF, World Bank, and Federal Reserve conduct business sentiment surveys to assess the impact of trade uncertainty on corporate decisions.

The Economic Significance of TPU

1. A high TPU Index discourages long-term investments as businesses fear sudden policy shifts.
2. Companies may diversify supply chains by moving production to different countries to minimize risks.
3. Central banks monitor TPU to determine interest rate policies—high TPU can lead to lower interest rates to stimulate borrowing and investment.
4. Governments may introduce stimulus packages or tax incentives to offset TPU-driven economic slowdowns.
5. Countries with high TPU may see a drop in foreign direct investment (FDI) as investors seek stable trade environments.
6. TPU movements shape trade negotiations, influencing policies on tariffs, imports, and exports.
7. Companies dependent on imports/exports often see stock price fluctuations due to TPU.
8. Uncertainty about tariffs may lead to currency depreciation, increasing import costs and inflation risks.

Examples 

1. In February 2025, former U.S. President Donald Trump announced a 25% tariff on all steel and aluminum imports, effective March 12, 2025, eliminating previous exemptions.
2. The European Union retaliated with countermeasures worth $28 billion, affecting various industries.
3. The U.S. also imposed an additional 25% tariff on Canadian steel and aluminum, raising total tariffs to 50%—a response to Ontario’s 25% surcharge on electricity exports to U.S. states.

Managing Trade Policy Uncertainty (TPU)

To mitigate risks associated with TPU, governments, businesses, and investors must adopt proactive strategies.

1. Stable & Transparent Trade Policies such as Clear, consistent trade policies help reduce uncertainty. Regular government-business communication prevents market disruptions.
2. Bilateral & Multilateral Trade Agreements such as Long-term trade agreements (e.g., USMCA, EU trade deals) provide stability. Strengthening World Trade Organization (WTO) rules can limit tariff unpredictability.
3. Flexible Monetary & Fiscal Policies such as Central banks can adjust interest rates to stabilize economies affected by trade uncertainty. Governments may introduce tax incentives and subsidies to support impacted industries.
4. Supply Chain Diversification Policies such as Encouraging businesses to diversify supply chains reduces dependence on single markets. Promoting domestic manufacturing strengthens local economies.
5. Supply Chain Resilience such as Diversify suppliers across multiple countries to avoid disruptions from tariffs or trade bans.
6. Currency hedging protects against exchange rate fluctuations.