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

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 re- formed. 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 down- turns, including slow recoveries. A central lacuna is the lack of attention to credit and the institutions pro- viding 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 on- going 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.