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Economic stability is the absence of excessive fluctuations in the macroeconomy. [1] [2] An economy with fairly constant output growth and low and stable inflation would be considered economically stable. An economy with frequent large recessions, a pronounced business cycle, very high or variable inflation, or frequent financial crises would be considered economically unstable.
Real macroeconomic output can be decomposed into a trend and a cyclical part, where the variance 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 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 with drift, with the drift component being the trend.
Democracy tends to improve economic stability. [3]
Macroeconomic instability can be brought on by the lack of financial stability, as exemplified by the Great Recession which was brought on by the financial crisis of 2007–2008.
Monetarists consider that a highly variable money supply leads to a highly variable output level. Milton Friedman believed that this was a key contributor to the Great Depression of the 1930s.
John Maynard Keynes believed, and subsequent Keynesians believe, that unstable aggregate demand leads to macroeconomic instability, while real business cycle theorists believe that fluctuations in aggregate supply drive business cycles.
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.
When a stabilization policy is implemented, it generally involves the use of either monetary policy or fiscal policy. Either of these may be advocated by Keynesian economists. However, they are generally opposed by monetarists and real business cycle 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.
Keynesian economics are the various macroeconomic theories and models of how aggregate demand strongly influences economic output and inflation. In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy. It is influenced by a host of factors that sometimes behave erratically and impact production, employment, and inflation.
Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes national, regional, and global economies. Macroeconomists study topics such as output/GDP and national income, unemployment, price indices and inflation, consumption, saving, investment, energy, international trade, and international finance.
Monetarism is a school of thought in monetary economics that emphasizes the role of policy-makers in controlling the amount of money in circulation. It gained prominence in the 1970s but was mostly abandoned as a direct guidance to monetary policy during the following decade because of the rise of inflation targeting through movements of the official interest rate.
Fischer Sheffey Black was an American economist, best known as one of the authors of the Black–Scholes equation.
In economics and political science, fiscal policy is the use of government revenue collection and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variables developed in reaction to the Great Depression of the 1930s, when the previous laissez-faire approach to economic management became unworkable. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics theorised that government changes in the levels of taxation and government spending influence aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target inflation and to increase employment. In modern economies, inflation is conventionally considered "healthy" in the range of 2%–3%. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilise the economy over the course of the business cycle.
Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, government institutions, and private sector firms.
In macroeconomics, a stabilization policy is a package or set of measures introduced to stabilize a financial system or economy. The term can refer to policies in two distinct sets of circumstances: business cycle stabilization or credit cycle stabilization. In either case, it is a form of discretionary policy.
The quantity theory of money is a hypothesis within monetary economics which states that the general price level of goods and services is directly proportional to the amount of money in circulation, and that the causality runs from money to prices. This implies that the theory potentially explains inflation. It originated in the 16th century and has been proclaimed the oldest surviving theory in economics.
The Austrian business cycle theory (ABCT) is an economic theory developed by the Austrian School of economics seeking to explain how business cycles occur. The theory views business cycles as the consequence of excessive growth in bank credit due to artificially low interest rates set by a central bank or fractional reserve banks. The Austrian business cycle theory originated in the work of Austrian School economists Ludwig von Mises and Friedrich Hayek. Hayek won the Nobel Prize in Economics in 1974 in part for his work on this theory.
Procyclical and countercyclical variables are variables that fluctuate in a way that is positively or negatively correlated with business cycle fluctuations in gross domestic product (GDP). The scope of the concept may differ between the context of macroeconomic theory and that of economic policy–making.
Monetary inflation is a sustained increase in the money supply of a country. Depending on many factors, especially public expectations, the fundamental state and development of the economy, and the transmission mechanism, it is likely to result in price inflation, which is usually just called "inflation", which is a rise in the general level of prices of goods and services.
Dynamic stochastic general equilibrium modeling is a macroeconomic method which is often employed by monetary and fiscal authorities for policy analysis, explaining historical time-series data, as well as future forecasting purposes. DSGE econometric modelling applies general equilibrium theory and microeconomic principles in a tractable manner to postulate economic phenomena, such as economic growth and business cycles, as well as policy effects and market shocks.
The neoclassical synthesis (NCS), or neoclassical–Keynesian synthesis is an academic movement and paradigm in economics that worked towards reconciling the macroeconomic thought of John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936) with neoclassical economics.
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based on microeconomics, especially rational expectations.
The Great Moderation is a period in the United States of America starting from the mid-1980s until at least 2007 characterized by the reduction in the volatility of business cycle fluctuations in developed nations compared with the decades before. It is believed to be caused by institutional and structural changes, particularly in central bank policies, in the second half of the twentieth century.
Stock market cycles are proposed patterns that proponents argue may exist in stock markets. Many such cycles have been proposed, such as tying stock market changes to political leadership, or fluctuations in commodity prices. Some stock market designs are universally recognized. However, many academics and professional investors are skeptical of any theory claiming to identify or predict stock market cycles precisely. Some sources argue identifying any such patterns as a "cycle" is a misnomer, because of their non-cyclical nature. Economists using efficient-market hypothesis say that asset prices reflect all available information meaning that it is impossible to systematically beat the market by taking advantage of such cycles.
Clark Warburton was an American economist. He was described as the "first monetarist of the post-World War II period," the most uncompromising upholder of a strictly monetary theory of business fluctuations, and reviver of classic monetary-disequilibrium theory and the quantity theory of money.
Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.
The new neoclassical synthesis (NNS), which is occasionally referred as the New Consensus, is the fusion of the major, modern macroeconomic schools of thought – new classical macroeconomics/real business cycle theory and early New Keynesian economics – into a consensus view on the best way to explain short-run fluctuations in the economy. This new synthesis is analogous to the neoclassical synthesis that combined neoclassical economics with Keynesian macroeconomics. The new synthesis provides the theoretical foundation for much of contemporary mainstream macroeconomics. It is an important part of the theoretical foundation for the work done by the Federal Reserve and many other central banks.
Real business-cycle theory is a class of new classical macroeconomics models in which business-cycle fluctuations are accounted for by real shocks. Unlike other leading theories of the business cycle, RBC theory sees business cycle fluctuations as the efficient response to exogenous changes in the real economic environment. That is, the level of national output necessarily maximizes expected utility, and governments should therefore concentrate on long-run structural policy changes and not intervene through discretionary fiscal or monetary policy designed to actively smooth out economic short-term fluctuations.