An economic stabilizing factor is any system and practice in economics that reduces the volatility of the business cycle by offsetting the effect on disposable income (disposable income). The most important automatic stabilizers include unemployment compensation and other transfer payment programs, agricultural price support, and household and business savings.

The ultimate goal of studying economic instability, including production, employment, and price volatility, is to provide the basis for stabilization policies—that is, the systematic use of fiscal and monetary policy to improve economic performance. Therefore, the main task is to explain how price, production and employment levels are determined, to make predictions about changes in these variables at a more practical level – predictions on which stabilization policy can be based.

Keynesian analysis

Of course, issues of economic stability and instability have always been a concern of economists. But, as an area of ​​private investigation, it emerged most powerfully at the confluence of two developments in the decade of the Great Depression of the 1930s. One is the development of national income statistics; The other is a reorientation of theoretical thinking, often referred to as the “Keynesian revolution”.

To understand why the theoretical contributions of John Maynard Keynes are so important for most of the twentieth century, one must study how modern economics works. This economy includes millions of people who engage in millions of different activities; These activities include the production, distribution and consumption of the various goods and services provided by the modern economy.

Some economic units are large and have senior managers and other managerial specialists who coordinate the productive activities of thousands of people. Apart from these relatively small islands of coordinated and pre-planned activities, most of the population is pursuing their many economic tasks without any carelessness.

It is like a very complex and ever-changing puzzle that is constantly being solved and solved by the market system. The breakdown of coordination of activity that occurred in the Great Depression of the 1930s was very rare—in fact, it only occurred once on such a scale—otherwise the regulatory system would not have been sustainable. The method of solving economic problems without thinking has been a major topic of broad economic theory since the days of British economist Adam Smith (1723-1790).

Coordination issues

If you select a particular household out of millions of economic units and study it over a period of time, you can budget the transactions of that household. The budget will appear as a long list of sales and purchase amounts. If one day this economic unit tried to do something different than what it already did (for example, buy less meat to buy another pair of shoes), the solution to the economic puzzle would be very different. At prices at that time, the supply of meat would outpace demand, and the demand for shoes would outpace supply.

Keynes’ view was, rightly or wrongly, that if the economy is to function as a coordinated system, the activity of each economic unit must be controlled in some way—and quite precisely. This is achieved through price incentives. By raising the price of one commodity (relative to the prices of all other commodities), any economic unit can generally demand less or supply more of it; By lowering the price, it can increase demand or reduce supply. Through price convergence, individual units are directed to adapt their activities to the general puzzle of market demand and supply. An organized market system cannot function if economic units cannot be controlled in this way.

So Keynesians believe that in any given situation, there is in theory only one price list that would make the puzzle right. However, the number of different goods that economic units choose to offer or demand in any given price list depends on many factors, all of which can change over time: the size of the population and the labor force; stock of material resources, technological and business skills; the “taste” of some consumer goods; and attitudes towards spending and saving, leisure and work, etc.

Government policies – tax and spending rates, welfare policies, money supply and debt – are also among the determinants of supply and demand. Any change in any of these determinants means that the list of prices that were previously balanced between all the different markets must change accordingly. If prices are ‘rigid’, the system cannot adapt and coordination collapses.

price flexibility

In order to maintain (or restore) the coordination of activity when the economy is disturbed by changes in these determinants, there is more: each individual price must move in the direction of restoring equilibrium. The necessity of adjusting prices in certain directions can be expressed as a condition of communication. In one extreme form: in order for a particular economic unit to plan its activities so that it “intertwines” with the activities of other units, it must know the intentions of everyone else in the system. When the fundamental determinants of market supply and demand change due to systemic imbalances, subsequent price movements must convey the required information to all concerned.

For example, one might assume that during a period of political crisis, supplies of crude oil from the Middle East were cut off. The immediate result will be a massive increase in global demand for oil and petroleum products – that is, supply will be much less than demand at current prices. At the same time, those who earn income from oil production in the Middle East will have less income, and excess supply will appear in the market to buy goods that those incomes were previously used to buy.

To adjust the system, orders must be made to all claimants to reduce oil consumption and to all other oil suppliers to increase production, bridging the gap between supply and demand. In fact, this is a consequence of rising world prices for oil and petroleum products – millions of users of gasoline and heating oil around the world will deal with the crisis of rising prices, which will also create profit incentives to increase supply. In a similar way, lower prices will fill the gap in the market where the initial turmoil increased supply).
Prices that are not fixed for institutional reasons will vary with increased demand and excess supply. When supply exceeds demand, frustrated buyers raise prices; And when supply exceeds demand, unsuccessful suppliers reduce supply. This mechanism solves the oil demand increase problem in the above chart. However, the question is whether, as a whole, it will always push every price towards a general equilibrium value.

No, Keynes said. He stressed that in some cases excess orders (or supplies) may not be reported “effectively”, so while some prices are at unbalanced levels, the bidding process beyond these inappropriate levels will not start. It was the defect of the traditional idea of ​​operating a price system that prompted Keynes to put forward the concept of ‘effective demand’.

For the pre-Keynesian economists, the implicit distinction between “effective” and (assumed) “inefficient” demand has no analytical meaning. The logic of conventional economic theory raises two possibilities that could make the price system ineffective: (1) In some markets, neither demanders nor suppliers respond to price incentives so that the ‘gap’ between supply and demand cannot be bridged. Adjusted prices and (2), for various institutional reasons in some markets, prices are “rigid” and will not budge from competitive pressures of excess demand or excess supply. Keynes identified a third possibility, which he said is responsible for the depth and duration of a severe depression: under certain conditions, even some prices may not change even if the willingness to buy and sell in the respective markets is inconsistent. Although there is no institutional reason to fix the price.