Mukti Bahadur Khatri (Ghimire)

DEPARTMENT OF ECONOMICS,
TRICHANDRA MULTIPLE CAMPUS, GHANTAGHAR
E-mail: [email protected]
Phone: 9843454835
 Introduction
 Macroeconomic stabilization is a condition in which a complex
framework for monetary and fiscal institutions and policies
is established to reduce volatility and encourage welfare-
enhancing growth. ... Stabilization of the economy is a prerequisite
for economic growth.
 Macroeconomic stability is the cornerstone of any successful effort
to increase private sector development and economic growth.
 Macroeconomic stability exists when key economic relationships
are in balance—for example, between domestic demand and
output, the balance of payments, fiscal revenues and
expenditure, and savings and investment.
 These relationships, however, need not necessarily be in exact
balance. Imbalances such as fiscal and current account deficits or
surpluses are perfectly compatible with economic stability provided
that they can be financed in a sustainable manner.
Unique set of Thresholds for each
Macroeconomic Variable
 There is no unique set of thresholds for each macroeconomic
variable between stability and instability.
 Rather, there is a continuum of various combinations of levels
of key macroeconomic variables (e.g., growth, inflation, fiscal
deficit, current account deficit, international reserves) that
could indicate macroeconomic instability.
 While it may be relatively easy to identify a country in a state
of macroeconomic instability (e.g., large current account
deficits financed by short-term borrowing, high and rising
levels of public debt, double-digit inflation rates, and stagnant
or declining GDP) or stability (e.g., current account and fiscal
balances consistent with low and declining debt levels,
inflation in the low single digits, and rising per capita GDP),
there is a substantial “gray area” in between where countries
enjoy a degree of stability, but where macroeconomic
performance could clearly be improved.
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 Finally, macroeconomic stability depends not only on the
macroeconomic management of an economy, but also on
the structure of key markets and sectors.
 To enhance macroeconomic stability, countries need to
support macroeconomic policy with structural reforms
that strengthen and improve the functioning of these
markets and sectors.
 Condition for Stabilization
 In most cases, addressing instability (i.e., stabilization) will require
policy adjustment; whereby a government introduces new
measures (possibly combined with new policy targets) in response
to the change in circumstances.
 Adjustment will typically be necessary if the source of instability is
a permanent (i.e., systemic) external shock or the result of earlier,
inappropriate macroeconomic policies.
 However, if the source of instability can be clearly identified as a
temporary shock (e.g., a one-time event) then it may be appropriate
for a country to accommodate it.
 Identifying whether a particular shock is temporary or is likely to
persist is easier said than done.
 Since there is often a considerable degree of uncertainty
surrounding such a judgment, it is usually wise to make a mistake
somewhat on the side of risk avoidance by assuming that the shock
will largely persist and by basing the corresponding policy
response on the appropriate adjustment.
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 In most circumstances where adjustment is necessary, both
monetary (or exchange rate) and fiscal instruments will have to be
used.
 In particular, successful adjustment to a permanent unfavorable
shock that worsens the balance of payments will often require a
sustained tightening of the fiscal stance, as this is the most
immediate and effective way to increase domestic savings and to
reduce domestic demand for foreign goods—two objectives
typically at the center of stabilization programs.
 Attempting to sustain aggregate demand through unsustainable
policies will almost certainly aggravate the long-run cost of a
shock, and could even fail in the short run to the extent that it
undermines confidence.
 In the long run, greater benefits to the people are to be had as a
result of the restoration of macroeconomic stability.
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 Countries in macroeconomic crisis typically have little choice
but to stabilize quickly, but for countries in the partial
stability, finding the right pace may prove difficult.
 In some cases, a lack of financing will drive the pace of
stabilization. Where financing is not a constraint, however,
policymakers will need to assess and carefully consider
various factors on a case-by-case basis in choosing the most
appropriate pace of stabilization.
Elements for Macroeconomic Stability
1. A track record of sound policy implementation
2. Low and stable inflation
3. Debt sustainability
4. Appropriate exchange rate
5. Adequate level of net international reserves
 The Roots of Stabilization
 Pioneering economist John Maynard Keynes argued that an
economy can experience a sharp and sustained period of stagnation
without a any kind of natural or automatic rebound or correction.
 Previous economists had observed that economies grow and
contract in a cyclical pattern, with occasional downturns followed
by a recovery and return to growth. Keynes disputed their theories
that a process of economy recovery should normally be expected
after a recession. He argued that the fear and uncertainty that
consumers, investors, and businesses face could induce a
prolonged period of reduced consumer spending, slow business
investment, and raised unemployment which would all reinforce
one another in a vicious circle.
 In the U.S., the Federal Reserve is tasked with raising or lowering
interest rates in order to keep demand for goods and services on an
even turn over.
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 To stop the cycle, Keynes argued, requires changes in policy
in order to manipulate aggregate demand.
 He, and the Keynesian economists who followed him, also
argued the reverse policy could be used to fight off excessive
inflation during periods of optimism and economic growth.
 In Keynesian stabilization policy, demand is stimulated to
counter high levels of unemployment and it is suppressed to
counter rising inflation.
 The two main tools in use today to increase or decrease
demand are to lower or raise interest rates for borrowing or
to increase of decrease government spending.
 These are known as monetary policy and fiscal policy,
respectively.
Reading Materials
 Edward Shapiro (1999); Macroeconomic Analysis, Fifth Edition,
New Delhi.
 Gardner Ackley (1969). Macroeconomic Theory, Macmillan
Company, New York.
 N.Gregory, Mankiw (2019). Macroeconomics , 10th Edition,
Macmillan Learning, New York www.bookx.net.
 R.G.D. Allen (1979). Macro-Economic Theory: A Mathematical
Treatment, Palgrave Macmillan.
 Richard T. Froyen (2013 ). Macroeconomics: Theories and
policies, Tenth Edition , University of North Carolina—Chapel
Hill.
 Robert J. Barro AND Xavier Sala-i-Martin (2004).Economic
Growth, Second Edition, The MIT Press Cambridge,
Massachusetts London, England.
 William H. Branson (1998). Macroeconomics Theory and Policy,
Second Edition, New Delhi.
 Various Journal Articles and websites.