Despite last month’s decline in the unemployment rate, there is plenty of evidence that both the U.S. and world economies remain weak. Policy uncertainty is a significant factor, which should signal Congress and the White House to avoid letting the economy go over the “fiscal cliff.”

Three indicators show signs of global economic weakness:

• The Brookings Institution-Financial Times Tracking Indexes for the Global Economic Recovery (TIGER), a gauge of post-recession economic strength, “shows growth momentum has dissipated in nearly all major advanced and emerging market economies.”
• The Organization for Economic Cooperation and Development (OECD) finds “that most major economies will continue to see weakening growth in the coming quarters.”
• The International Monetary Fund downgraded its forecast for world economic growth.

Why the pessimism? The IMF’s chief economist cites “uncertainty in advanced economies” as part of the reason.

What’s happening globally is also occurring on a smaller level. The latest U.S. Chamber of Commerce’s Small Business Outlook Index finds that 87% of small business owners want more certainty from Washington. And in a story on the National Federation of Independent Business’ (NFIB) small business index, Bloomberg reports, “[B]usiness leaders may be putting off some of their hiring and investment decisions because of a lack of clarity on tax and regulatory policy.”

Economists Scott Baker, Nicholas Bloom, and Steven Davis (whose work I’ve mentioned many times) connect policy uncertainty to lower business growth:

[W]hen firms are uncertain, it is expensive to invest or disinvest and to hire or fire. So uncertainty encourages firms to delay, more so for longer-lived investments and decisions that are costlier to reverse.

As we are seeing, businesses hunker down and wait to see what policies are settled upon before investing or spending, which holds back the economy from growing as fast as it otherwise would.

As we get closer to the fiscal cliff’s automatic tax increases and across-the-board spending cuts, worries about uncertainty only increase. There has been some discussion, some irresponsible bluster, and even a call for tax increases to avoid going over the cliff, but for now we wait for November’s elections and for Congress to return for a lame duck session.

All the while, businesses wait with their wallets closed as a cloud hangs overhead. “As anxiety and uncertainty about the fiscal cliff have increased, businesses have made the prudent decision to delay investment spending decisions,” Ward McCarthy, managing director at the investment bank, Jefferies & Co., told the Washington Times.

Economic observers like Bloomberg’s editors are noticing the impact policy uncertainty is having. In an editorial, they write:

Last year’s showdown over whether to raise the U.S. debt limit increased the nation’s borrowing costs by $1.3 billion in 2011 alone, according to the Government Accountability Office, and Federal Reserve Chairman Ben S. Bernanke blamed the polarized debate for disrupting the economic recovery. A new Federal Reserve study shows that had there been no uncertainty over the past four years, the U.S. unemployment rate would have been closer to 6 percent or 7 percent than the 8 percent to 9 percent actually registered.

There is a way forward to ease some of the uncertainty by not going over the fiscal cliff and avoiding a recession. The U.S. Chamber is advocating a two-pronged approach. First, avoid the largest tax increase in U.S. history by extending the 2001/2003 tax rates as well as expired and soon-to-be expired tax provisions while finding smarter budget cuts to replace the meat-ax cuts about to happen. Next, work on comprehensive, pro-growth tax reform while developing a plan for getting federal government spending—especially entitlements--under control.

Yogi Berra once said, “When you come to a fork in the road, take it.” When it comes to the fiscal cliff, leaders in Washington have to be decisive and choose a pro-growth path that brings more certainty and encourages businesses to create jobs.