Stable Growth in an Era of Crises: Learning from Economic Theory and History

Year 2013, Volume: 2 Issue: 1, 1 - 39, 01.01.2013

Joseph E. Stiglitz

Abstract

The financial crisis and the Great Recession to which it gave rise exposed the deep flaws in standard macro-economic models, and in the way those models were deployed. In this paper, based on a talk given to the Turkish Economic Association in November 2012, Joseph E. Stiglitz discusses the range of these deficiencies and the ways in which the models must be reformed. The paper first examines five particular issues in the current policy debate and explains why the standard model provides a misguided framework for addressing them. The paper identifies the fundamental flaws in the standard model, and argues that in trying to fine tune the models for “normal” periods, it failed to address the more profound question of how to explain deep downturns, including slow recoveries. A central lacuna is the lack of attention to credit and the institutions providing it. It explains how a better understanding of banks would have led to better ways to recapitalize the banking system than those employed in the aftermath of the crisis. Finally, the paper relates all of these issues to the ongoing Euro crisis, showing in particular that the structure of the euro, though
seemingly designed to improve the efficiency of resource allocations, has actually created an unstable and inefficient system.

Keywords

State of macroeconomics, macroeconomic models and their deficiencies, economic crises, macroeconomic policies, recapitalization of the banking system, the Euro crisis.

Thanks

Paper presented to the Turkish Economic Association on November 2, 2012. This lecture is based on joint research over a long period of time with Bruce Greenwald, to whom I am greatly indebted. It builds on Stiglitz (2011). I am also indebted to Arjun Jayadev and Rob Johnson for discussions on the issues raised in this lecture. Financial support from the Institute for New Economic Thinking (INET) is gratefully acknowledged.

References

• Alesina, Alberto and Silvia Ardagna, (2010), “Large Changes in Fiscal Policy: Taxes versus Spending,” in Tax Policy and the Economy, Jeffrey R. Brown (ed.), vol. 24 (Chicago: University of Chicago Press, 2010), pp. 35-68.
• Allen, Franklin and Douglas Gale, (2000), Comparing Financial Systems, Cambridge, Mass.: MIT Press.
• Baker, Dean, (2010), "The Myth of Expansionary Fiscal Austerity," CEPR, Washington, DC.
• Battiston, Stefano, Domenico Delli Gatti, Bruce Greenwald, and Joseph E. Stiglitz, (2007), “Credit Chains and Bankruptcy Propagation in Production Networks,” Journal of Economic Dynamics and Control, 31(6), pp. 2061-2084.
• Battiston, Dominico Delli Gatti, Mauro Gallegati, Bruce Greenwald, and Joseph E. Stiglitz, (2012a), “Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk,” Journal of Economic Dynamics and Control, 36, pp. 1121-1141.
• Battiston, Stefano, Dominico Delli Gatti, Mauro Gallegati, Bruce Greenwald, and Joseph E. Stiglitz, (2012a), “Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk”, Journal of Economic Dynamics and Control, 36, pp. 1121-1141.
• Battiston, Stefano, Dominico Delli Gatti, Mauro Gallegati, Bruce Greenwald, and Joseph E. Stiglitz, (2012b), “Default Cascades: When Does Risk Diversification Increase Stability", Journal of Financial Stability, 8 (3), pp. 138-149.
• De Masi, G., Y. Fujiwara, M. Gallegati, and B. Greenwald and J. E. Stiglitz, (2011), “An Analysis of the Japanese Credit Network”, Evolutionary and Institutional Economics Review, 7 (2), pp, 203-232.
• Delli Gatti, Domenico, Mauro Gallegati, Bruce Greenwald, Alberto Russo, and Joseph E. Stiglitz, (2006), “Business Fluctuations in a Credit- Network Economy”, Physica A, 370, pp. 68-74.
• Delli Gatti, Domenico, Mauro Gallegati, Bruce Greenwald, Alberto Russo, and Joseph E. Stiglitz, (2012a), “Mobility Constraints, Productivity Trends, and Extended Crises”, Journal of Economic Behavior and Organization, 83 (3), pp.375-393.
• Delli Gatti, Domenico, Mauro Gallegati, Bruce Greenwald, Alberto Russo, and Joseph E. Stiglitz, (2012b) “Sectoral Dislocations and Long-Run Cycles", in the Global Macro Economy and Finance, F. Allen, M. Aoki, J.-P. Fitoussi, N. Kiyotaki, R. Gordon and J. E. Stiglitz, eds., IEA Conference Volume 150 (3), Hounmills, UK and New York: Palgrave, pp. 61-97.
• Field, Alexander, (2011) A Great Leap Forward: 1930s Depression and U.S. Economic Growth, New Haven: Yale University Press.
• Gallegati, Mauro, Bruce Greenwald, Matteo Richiardi, and Joseph E. Stiglitz, (2008), “The Asymmetric Effect of Diffusion Processes: Risk Sharing and Contagion”, Global Economy Journal, 8 (3), Article 2, available at http://www.bepress.com/gej/vol8/iss3/2/ (accessed March 29, 2011).
• Greenwald, Bruce and J. E. Stiglitz, (1986), Externalities in Economies with Imperfect Information and Incomplete Markets”, Quarterly Journal of Economics, Vol. 101, No. 2, May 1986, pp. 229-264.
• Greenwald, Bruce and J. E. Stiglitz, (1987a), “Keynesian, New Keynesian, and New Classical Economics”, Oxford Economic Papers, 39, March 1987, pp.119-133.
• Greenwald, Bruce and J. E. Stiglitz, (1987b), “Imperfect Information, Credit Markets, and Unemployment”, European Economic Review, 31, pp. 444-456.
• Greenwald, Bruce and J. E. Stiglitz, (1988a), “Information, Finance Constraints, and Business Fluctuations”, Symposium on Monetary Theory (Proceedings of Taipei), Institute of Economics, Academia Sinica, pp. 299-336.
• Greenwald, Bruce and J. E. Stiglitz, (1988b), “Imperfect Information, Finance Constraints, and Business Fluctuations”, in Finance Constraints, Expectations, and Macroeconomics, M. Kohn and S.C. Tsiang, eds., Oxford: Oxford University Press, pp. 103-140.
• Greenwald, Bruce and J. E. Stiglitz, (1988c), “Money, Imperfect Information, and Economic Fluctuations”, with B. Greenwald, in Finance Constraints, Expectations, and Macroeconomics, M. Kohn and S.C. Tsiang, eds., Oxford: Oxford University Press, pp.141-165.
• Greenwald, Bruce and J. E. Stiglitz, (1990), “Macroeconomic Models with Equity and Credit Rationing”, in Asymmetric Information, Corporate Finance, and Investment, R. B. Hubbard, ed., University of Chicago Press, pp. 15-42.
• Greenwald, Bruce and J. E. Stiglitz, (1993a), “Financial Market Imperfections and Business Cycles”, Quarterly Journal of Economics, 108 (1), pp. 77-114.
• Greenwald, Bruce and J. E. Stiglitz, (2003), Towards a New Paradigm of Monetary Economics, Cambridge: Cambridge University Press.
• Griffith-Jones, Stephany, (2013), “From Austerity to Growth in Europe: Some Lessons from Latin America”, In International Economic Association, Volume on the 2012 Pretoria, South Africa Roundtable on Industrial Policy.
• Haldane, Andrew G., (2009), “Rethinking the Financial Network”, Address to the Financial Students Association, Amsterdam, April. Available at http://www.bankofengland.co.uk/publications/speeches/2009/speech386.pdf (accessed October 31, 2012).
• Haldane, Andrew G., and Robert M. May, (2010), “Systemic Risk in Banking Ecosystems”, Working Paper, University of Oxford.
• Herndon, Thomas, Michael Ash, and Robert Pollin, (2013), “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff”, University of Massachusetts, Amherst Political Economy Research Institute Working Paper No. 322, Available Online at http://www.peri.umass.edu/fileadmin/pdf/working_papers/ working_papers_301-350/WP322.pdf (accessed May 31, 2013).
• Jayadev, Arjun and M. Konczal, (2010), "The Boom not the Slump: The Right Time for Austerity", The Roosevelt Institute, August 23.
• Jeanne, Olivier and Anton Korinek, (2010), “Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach”, American Economic Review, 100 (2), pp. 403–407.
• Jeanne, Olivier and Anton Korinek, (2012), “Managing Credit Booms and Busts: A Pigouvian Taxation Approach”, NBER Working Paper No. 16377, available at http://www.nber.org/papers/w16377.pdf (accessed October 2012).
• Kindleberger, Charles, (1978), Manias, Panics, and Crashes: A History of Financial Crises, New York: Basic Books.
• Konczal, Mike, (2011), “Dramatic Job Revisions Bust Structural Unemployment Myths”, The Roosevelt Institute, May 11, available at http://www.rooseveltinstitute.org/sites/all/files/JobOpeningCorrections.pdf (accessed October 31, 2012).
• Lin, Justin Yifu, (2012), New Structural Economies: A Framework for Rethinking Development Policies, Washington, DC: The World Bank.
• Lin, Justin Yifu and Joseph E. Stiglitz, (2013), Introduction to International Economic Association volume on the 2012 Washington DC roundtable on industrial policy.
• Lin, Justin Yifu, Ebrahim Patel, and Joseph E. Stiglitz, (2013) Introduction to International Economic Association volume on the 2012 Pretoria, South Africa Roundtable on Industrial Policy.
• Miller, Marcus and Lei Zhang, (2013), “Beyond austerity: an SPV to save the Eurozone?” in International Economic Association volume on the 2012 Pretoria, South Africa Roundtable on Industrial Policy.
• Minsky, Hyman P., (1982), Can “It” Happen Again? : Essays on Instability and Finance, Armonk, NY: M.E. Sharpe.
• Mundell, Robert, (1961), “A Theory of Optimum Currency Areas”, The American Economic Review, 51 (4): pp. 657-665.
• Neary, P. and J. E. Stiglitz, (1983), “Toward a Reconstruction of Keynesian Economics: Expectations and Constrained Equilibria”, Quarterly Journal of Economics, 98, Supplement, pp. 199-228.
• Prescott, Edward C., (2006), Lecture at Trinity University in San Antonio, Texas, available at http://www.trinity.edu/nobel/Prescott/Prescott_Webquotes.htm (accessed June 12, 2013).
• Reinhart, Carmen M. and Kenneth S. Rogoff, (2010) “Growth in a Time of Debt”, American Economic Review 100 (2), pp. 573-578.
• Sandleris, Guido, (2012), “The Cost of Sovereign Defaults: Theory and Empirical Evidence”, Business School Working Papers, No. 2, Universidad Torcuato Di Tella.
• Solow, Robert, (2012), “Fiscal Policy”, in Olivier Blanchard, David Romer, Michael Spence, and Joseph Stiglitz, eds., In the Wake of the Crisis: Leading Economists Reassess Economic Policy, Cambridge, Massachusetts: The MIT Press, pp. 73-76.
• Stiglitz, J. E., (1977), “Theory of Local Public Goods”, in The Economics of Public Services, M.S. Feldstein and R.P. Inman, eds., MacMillan Publishing Company, pp. 274-333. (Paper presented to IEA Conference, Turin, 1974).
• Stiglitz, J. E., (1982), “Information and Capital Markets”, in William F. Sharpe and Cathryn Cootner, eds., Financial Economics: Essays in Honor of Paul Cootner, Prentice Hall, New Jersey, pp. 118-158. Also NBER Working Paper No.678. Reprinted in Selected Works of Jospeh E. Stiglitz,Volume II, Oxford: Oxford University Press, forthcoming, pp. 55-84.
• Stiglitz, J. E., (1983a), “The Theory of Local Public Goods Twenty-Five Years After Tiebout: A Perspective”, in Local Provision of Public Services: The Tiebout Model After Twenty-Five Years, G.R. Zodrow, ed., New York: Academic Press, pp. 17-53.
• Stiglitz, J. E., (1983b), “Public Goods in Open Economies with Heterogeneous Individuals”, in Locational Analysis of Public Facilities, J.F. Thisse and H.G. Zoller, eds., Amsterdam: North-Holland, pp. 55-78.
• Stiglitz, J. E., (2010a), “Contagion, Liberalization, and the Optimal Structure of Globalization,” Journal of Globalization and Development, 1 (2), Article 2.
• Stiglitz, J. E., (2010b), “Sovereign Debt: Notes on Theoretical Frameworks and Policy Analyses”, in Overcoming Developing Country Debt Crises, B. Herman, J.A. Ocampo, and S. Spiegel, eds., Oxford: Oxford University Press, pp. 35-69.
• Stiglitz, J. E., (2010c), Freefall: America, Free Markets, and the Sinking of the World Economy, New York: WW Norton
• Stiglitz, J. E., (2011), “Rethinking Macro-economics: What Failed and How to Repair It”, Journal of the European Economic Association, 9 (4), pp. 591-645.
• Stiglitz, J. E., (2012), The Price of Inequality, New York, W.W. Norton (Spanish edition published by Taurus).
• Stiglitz, J. E., José Antonio Ocampo, Shari Spiegel, Ricardo Ffrench-Davis, and Deepak Nayyar, (2006), Stability with Growth: Macroeconomics, Liberalization, and Development, The Initiative for Policy Dialogue Series, Oxford: Oxford University Press.
• Stiglitz, J. E., A. Sen, and J.P. Fitoussi, (2010), Mismeasuring Our Lives: Why GDP Doesn’t Add Up, New York: The New Press. (The original report of the International Commission on the Measurement of Economic Performance and Social Progress was published in 2009; it is available at http://www.stiglitz-sen-fitoussi.fr/en/index.htm (accessed May 16, 2011).
• Stiglitz, J. E., and Mark Zandi, (2012), "The One Housing Solution Left: Mass Mortgage Financing", New York Times, op ed, August 12.
• Stiglitz, J. E., and members of a UN Commission of Experts, (2010), The Stiglitz Report: Reforming the International Monetary and Financial Systems in the Wake of the Global Crisis, with Members of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, New York: The New Press, 2010.
• Woodford, Michael, (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press.
• Woodford, Michael, (2009), “Convergence in Macro-economics: Elements of the New Synthesis”, American Economic Journal: Macro-economics, 1 (1), pp. 267–279.
• Yildiz, Izzet, (2011), “Leverage and Default Risk of Financial Intermediaries under Asymmetric Information”, Working Paper, Columbia University, September.