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Economic stability is the absence of excessive fluctuations in themacroeconomy.[1][2] An economy with fairly constantoutput growth and low and stableinflation would be considered economically stable. An economy with frequent largerecessions, a pronouncedbusiness cycle, very high or variableinflation, or frequentfinancial crises would be considered economically unstable.
Real macroeconomic output can be decomposed into atrend and acyclical part, where thevariance of the cyclical series derived from the filtering technique (e.g., theband-pass filter, or the most commonly usedHodrick–Prescott filter) serves as the primary measure of departure from economic stability.
A simple method of decomposition involvesregressing real output on the variable "time", or on apolynomial in the time variable, and labeling the predicted levels of output as the trend and theresiduals as the cyclical portion. Another approach is to model real output asdifference 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 offinancial stability, as exemplified by theGreat Recession which was brought on by the2008 financial crisis.
Monetarists consider that a highly variablemoney supply leads to a highly variable output level.Milton Friedman believed that this was a key contributor to theGreat Depression of the 1930s.
John Maynard Keynes believed, and subsequentKeynesians believe, that unstableaggregate demand leads to macroeconomic instability, whilereal business cycle theorists believe that fluctuations inaggregate supply drivebusiness 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 eithermonetary policy orfiscal policy. Either of these may be advocated byKeynesian economists. However, they are generally opposed bymonetarists andreal business cycle theorists. Monetarists believe that well-intentionedcountercyclical 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 thesupply side of the economy.