Economic stability is the absence of excessive fluctuations in the macroeconomy.'The IMF Promotes Global Economic Stability'
/ref> An economy with fairly constant output growth and low and stable

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

would be considered economically stable. An economy with frequent large

recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...

s, a pronounced business cycle, very high or variable

, or frequent financial crises would be considered economically unstable.

Measuring stability

Real macroeconomic output can be decomposed into a trend and a

cyclical Cycle, cycles, or cyclic may refer to: Anthropology and social sciences * Cyclic history, a theory of history * Cyclical theory, a theory of American political history associated with Arthur Schlesinger, Sr. * Social cycle, various cycles in soc ...

part, where the

variance In probability theory and statistics, variance is the expectation of the squared deviation of a random variable from its population mean or sample mean. Variance is a measure of dispersion, meaning it is a measure of how far a set of numbe ...

of the cyclical series derived from the filtering technique (e.g., the band-pass filter, or the most commonly used Hodrick–Prescott filter) serves as the primary measure of departure from economic stability. A simple method of decomposition involves regressing real output on the variable “time”, or on a

polynomial In mathematics, a polynomial is an expression consisting of indeterminates (also called variables) and coefficients, that involves only the operations of addition, subtraction, multiplication, and positive-integer powers of variables. An exampl ...

in the time variable, and labeling the predicted levels of output as the trend and the residuals as the cyclical portion. Another approach is to model real output as

difference stationary In probability theory and statistics, a unit root is a feature of some stochastic processes (such as random walks) that can cause problems in statistical inference involving time series models. A linear stochastic process has a unit root if 1 is ...

with drift, with the drift component being the trend.

Causes of instability

Macroeconomic instability can be brought on by the lack of financial stability, as exemplified by the

Great Recession The Great Recession was a period of marked general decline, i.e. a recession, observed in national economies globally that occurred from late 2007 into 2009. The scale and timing of the recession varied from country to country (see map). At ...

which was brought on by the

financial crisis of 2007–2008 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of ...

. Monetarists consider that a highly variable

money supply In macroeconomics, the money supply (or money stock) refers to the total volume of currency held by the public at a particular point in time. There are several ways to define "money", but standard measures usually include currency in circu ...

leads to a highly variable output level.

Milton Friedman Milton Friedman (; July 31, 1912 – November 16, 2006) was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the ...

believed that this was a key contributor to the

Great Depression The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagio ...

of the 1930s.

John Maynard Keynes John Maynard Keynes, 1st Baron Keynes, ( ; 5 June 1883 – 21 April 1946), was an English economist whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. Originally trained in ...

believed, and subsequent Keynesians believe, that unstable aggregate demand leads to macroeconomic instability, while

real business cycle Real business-cycle theory (RBC theory) is a class of new classical macroeconomics models in which business-cycle fluctuations are accounted for by real (in contrast to nominal) shocks. Unlike other leading theories of the business cycle, RBC t ...

theorists believe that fluctuations in

aggregate supply In economics, aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that fir ...

drive business cycles.

Effects of instabilities

Economic instability can have a number of negative effects on the overall welfare of people and nations by creating an environment in which economic assets lose value and investment is hindered or stopped. This can lead to unemployment, economic recession, or in extreme cases, a societal collapse.

Stabilization policy

When a stabilization policy is implemented, it generally involves the use of either

monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...

fiscal policy In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variabl ...

. Either of these may be advocated by Keynesian economists. However, they are generally opposed by monetarists and

theorists. Monetarists believe that well-intentioned contercyclical monetary policy will generally be counterproductive, adding to the existing variability of real output, and real business cycle theorists believe that such policies are misguided because they do not address the underlying causes of fluctuations, which they believe lie on the supply side of the economy.

References

External links