Economic stability

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. 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. Macroeconomic instability can be brought on by financial instability, as exemplified by the recession of 2007–2012 which was brought on by the 2007 financial crisis. 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.