When do Countercyclical Policies Increase Economic Stability?

In an influential paper, Friedman (1953) showed that even countercyclical fiscal or monetary policies can be destabilizing if they are weakly correlated with the state of the economy. I show that this surprising conclusion is sensitive to the way in which uncertainty is measured. If the size of fluctuations are measured using mean absolute deviation instead of variance, every countercyclical policy that does not convert recessions into booms improves economic stability. However, efforts to “fine tune” the economy by responding to small fluctuations can reduce stability irrespective of the measure of uncertainty that is used.