What is economic instability?

Answer 1

Economic Instability

Readers Question: my question is whether economic instability means high and fluctuated inflation ,employment and unsustainable growth or has other definition?

Economic instability can take various forms. In recent years, we have witnessed a few examples of this. Certainly high inflation (especially when unanticipated) creates instability. But, I also feel there are other factors which can cause instability such as volatile asset prices, volatile levels of growth, volatile bank lending, even labour market unrest.

Types of Economic Instability.

Inflation. A period of high inflation create instability. When prices are rising rapidly, firms and consumers become uncertain about future costs, prices and profitability - this uncertainty tends to reduce their willingness to invest. When inflation is very high and when inflation is above interest rates, the real value of money can decline quickly causing savings to fall in value. When money loses value, economies can become very unstable as consumers have to resort to a barter economy. For example, the hyper inflation of Zimbabwe created great economic misery and a collapse in living standards.

Asset Bubbles. The recent credit crunch has shown how powerful asset bubbles and busts can be in effecting the economy. Rising asset prices (especially housing) encourage spending as people remortgage their house. But, a fall in house prices causes this wealth effect to evaporate and people become cautious over spending.

Confidence. Economic instability is linked to confidence. When the economy shows signs of instability, consumers and firms become risk averse. Typically, when people worry over the future, they save a higher % of their income. This higher saving rate can cause a larger fall in output and more instability. It is known as the paradox of thrift.

Other types of economic instability

Labour Unrest. Large scale strikes can cause lost output and shortage of key public services. (e.g. Winter of discontent in 1970s)

Banking system. When banking system ran out of credit and there was a fall in interbank lending, many realised how reliant on the banking sector the economy was.

Booms and Busts. Typically economies grow at a long run trend rate which is sustainable. However, a boom and bust creates instability because a period of high growth is followed by a recession and decline in output. Declining output typically leads to higher unemployment and the instability of lower incomes.

Tejvan Pettinger sighted by Ojasanya Olalekan (2012).