Given the large amount of commentary on the state of the economy, I've found that most of the time the theme of the articles are always that there is something wrong/ abnormal with regards to the economy.There seems to be call for change of policy all the time.

With all this noise its often difficult to know when a "business as usual" policy should be implemented (i.e nothing should be changed or advanced). When is it possible that we should change nothing in an macroeconomy (i.e no changes in interest rates, domestic taxes or trade taxes)?

What properties would a country with a stable economy posess?

  • $\begingroup$ The question appears to be asking “what properties would a country with a stable policy possess?” We could imagine an economy with stable policies (interest rates, taxes, etc.) but with instability in economic variables. I think this should be clarified. $\endgroup$ – Brian Romanchuk Feb 16 '18 at 19:04
  • $\begingroup$ @BrianRomanchuk I want to know under what circumstances would an economist recommend absolute no changes to current policy. Im not sure if I understand your criticism. $\endgroup$ – EconJohn Feb 16 '18 at 20:24
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    $\begingroup$ The wording is the issue. You write “stable economy”, but what you mean is “stable policy.” This will confuse people scanning the question quickly. It’s just a cosmetic change, but it helps future readers. $\endgroup$ – Brian Romanchuk Feb 16 '18 at 22:34

I’ll cover two of the possible policies that can be stable: interest rates and fiscal policy.

I will assume that a “stable” interest rate policy is to keep the policy rate (e.g. Fed Funds in the United States) unchanged. This is is a case discussed in “mainstream” economics, and the argument is that such a policy leads to inflation drifting at random. (As in Section 2.4.1 of “Monetary Policy, Inflation, and the Business Cycle” by Jordi Galí.) In other words, if you lose monetary policy, you lose control of inflation.

Of course, the policy rate has been at the same level for years in many countries, and not much happened. The reason why the policy rate was stable was usually that the economy was growing slowly, and no inflation risk was seen. That is, the economy was in a sense (temporarily) “stable”, and policy rate reflectd that.

Even if the central bank says it will not change short rates, bond yields would likely still move around on the basis that the policy will not be sustained. So things like mortgage rates would still move.

Some critics of “mainstream” economics think that the models that lead to this inflation instability are incorrect. In particular, some proponents of Modern Monetary Theory argue in favour of locking the policy rate at 0% forever. That is very much a minority position.

If we turn to fiscal, I am unaware of any formal theory. In basic “mainstream” models, fiscal policy is often left unchanged. However, this was not viewed as having much if an effect, since monetary policy is believed to be the main policy variable.

We have seen unchanged tax rates for years in many countries, and I do not believe anything unusual was associated with that. However, taxe rates are only part of fiscal policy. Spending changes from year-to-year, and in the real world, that is unlikely to change. For example, the Canadian Federal Government is helping pay for a bridge near where I live. That spending will hopefully cease when that construction is complete.

To top it off, the dollar amounts of deficits vary based on the business cycle. If people lose jobs, they pay less taxes and end up receiving more governmental assistance. So if someone defines fiscal policy “stability” as an unchanged fiscal deficit, that is almost guaranteed to never happen. However, these changes to the deficit are believed by some economists to help dampen the business cycle (the “automatic stabilisers”). (I see little discussion of automatic stabilisers in modern “mainstream” theory, but it was discussed more by the old Keynesians.)

In summary, “stable” policy settings imply that the government cannot lean against fluctuations like recessions, or control inflation. Economists of the Keynesian persuasion would likely argue that this will result in deep depressions, such as in the 1800s. Many non-Keynesians would dispute that.

  • $\begingroup$ A "stable economy" does not mean that variables are all static or have an unchanging growth rate. As an example, consider differences between "structural deficit" and "cyclical deficit" (whether nominal amounts or debt/GDP ratio is maybe a different question). Say, the business cycle from trough to trough is 8 years. With a structural deficit, at each 8 year period you will observe higher debt. But if the deficit is only cyclical, then in slower growth or recession debt will rise and in higher growth debt will fall, but every 8 years you would observe the same ("stable") debt situation. $\endgroup$ – nathanwww Mar 20 '18 at 2:33

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