A Balanced Debate About Reforming Macroeconomics

Guest post by Joseph E. Stiglitz, Columbia University, and
co-host of the Conference on Macro and Growth Policies in the Wake of the Crisis

The most remarkable aspect of the recent conference at the IMF was the broad consensus that the macroeconomic models that had been relied upon in the past and had informed major aspects of monetary and macro-policy had failed. They failed to predict the crisis; standard models even said bubbles couldn’t exist—markets were efficient. Even after the bubble broke, they said the effects would be contained. Even after it was clear that the effects were not “contained,” they provided limited guidance on how the economy should respond. Maintaining low and stable inflation did not ensure real economic stability. The crisis was “man-made.” While in standard models, shocks were exogenous, here, they were endogenous.

There was even remarkable consensus about many elements of policy in responding to the crisis: fiscal policy can work; we need to be wary of empirical studies based on circumstances markedly different from the current situation (where households are overleveraged, where interest rates have reached the zero lower bound, etc.).

There were large areas of consensus for the longer run: central banks will focus on more than just inflation, especially financial stability; but there will be a real challenge in developing an integrated approach.


The ultimate objective of a central bank is to stabilize the real economy, and financial and price stability both need to be seen as instruments toward this and other ultimate objectives. In achieving real stability, much stronger financial regulation will be required—both because of agency issues and the pervasiveness of externalities, self-regulation cannot be relied upon. Real stability will require a full range of tools for capital account management, including cross-border regulations on capital flows.

While the crisis has brought into focus the inadequacies of the standard macroeconomic models and the policy tenets that were derived from them, not surprisingly other aspects of conventional wisdom, related to growth, were also discussed. Again, there was a surprising consensus that industrial policies have played an important role in enhancing growth (though other policies, like “rule of law” and macroeconomic stability are also important). The discussion went well beyond the tired critique of “picking winners” to a more insightful analysis, based on the well-known and documented externalities associated with learning and development, instances in which markets on their own do not necessarily work well.

Perhaps the major failing of some of the earlier models was that, while the attempt to incorporate micro-foundations was laudable, it was important that they be the right micro-foundations. This crisis, like so many earlier crises, was a credit crisis; but few of the macroeconomic models modeled credit; neither banks (perhaps particularly surprising in models used by central banks) nor securitization was typically incorporated into the analysis. While in normal times, credit and money may be highly correlated, this is not so in the usual times surrounding crises, which is when we need to turn to models for guidance. Fortunately, there has been a great deal of modeling of banks and credit creation; the task ahead is to incorporate the insights of these models into the kinds of macro-models being used by policymakers.

In any meeting such as this, it’s worth noting what was not discussed, or only mentioned briefly. The fact that countries with central banks that were not independent performed so much better than some of those that were—partly because the latter were “cognitively captured” by the financial markets that they were supposed to regulate—should perhaps lead to rethinking of doctrines concerning central bank independence. Standard models not only don’t provide a good explanation of the origins of a crisis, such as the one Europe and America are experiencing, they also don’t adequately explain the slowness of the recovery. After all, the human and physical assets that existed before the crisis are still here; indeed, in a real sense, having corrected the distortions associated with the crisis, output should be higher. Yet, for years, output has remained substantially below its potential. And it’s even the case for the United States, which long prided itself on having flexible labor markets.

Many of those who had been advocates of the old policies, while seeing their limits, cautioned about letting the pendulum swing too far to the other side: inflation had been a serious problem in the past, so in focusing on other variables, it was important not to lose sight of the risks which high and variable inflation can impose; self-regulation clearly failed, but it can still be part of an overall regulatory scheme; capital flows bring benefits, and these should not be lost sight of.

In short, the conference made an important contribution in invigorating a balanced debate about reforming macroeconomics.


 Other conference-related blog posts:

2017-04-15T14:27:43-05:00March 22, 2011|


  1. Rodger Malcolm Mitchell March 22, 2011 at 12:22 pm

    “Standard models not only don’t provide a good explanation of the origins of a crisis, such as the one Europe and America are experiencing, they also don’t adequately explain the slowness of the recovery.”

    Part of the problem may be that the European crisis is so much different from the American crisis, and to lump them together is to miss the point. The European crisis (or more correctly, the euro crisis), was an inevitable result of nations surrendering control over their sovereign money. They became monetarily non-sovereign.

    A monetarily non-sovereign nation cannot create its own money and so cannot survive long-term on taxes alone. It needs money coming in from outside its borders. The PIIGS, for instance, are starved for money.

    The U.S., in contrast, is Monetarily Sovereign, and has the unlimited ability to create money. Today, America’s recovery is hampered by those who do not understand that federal deficits are necessary for economic growth. The debt-hawks are starving America.

    Rodger Malcolm Mitchell

  2. Per Kurowski March 22, 2011 at 1:06 pm

    @Joseph E. Stiglitz “self-regulation clearly failed”

    Basel II required 8 percent of capital from banks when doing lending or investing in what was rated BBB+ to BB-, and that 8 percent has proven more than sufficient. It is only in the areas covered with AAA to A ratings where the real crisis surged and these where areas where Basel II allowed 60 to 1 and higher bank leverages… which dramatically increased the expected net of risk returns of banks when doing business in areas officially denominated as low risk, in comparison to the expected net of risk returns on bank capital achievable in areas officially determined as “risky”.

    It is clear that only economist professors who have not had their hands soiled with the boring details of bank regulations can explain this in terms of “self regulation clearly failed”

    @Joseph E. Stiglitz “Standard models… they also don’t adequately explain the slowness of the recovery.”

    Perhaps Professor Stiglitz would do well to have a little conversation with the manager of the bank where he deposits his professor salary. Then he would find out that if the bank relends his deposit to a local business or entrepreneur, it would be required to put up a substantial amount of capital, but if that same bank lends that same money to the US government, and so that instead a bureaucrat can relend the money to a small business or entrepreneur of his bureaucratic choosing, then the bank would not be required to put up any capital. Perhaps that knowledge could enlighten Professor Stiglitz about the causes for the slowness of the recovery.

    I guess there is no need for me to explain why I never get invited to attend these conferences… the experts there would then perhaps not be able to achieve their so comforting consensus…but let me take the opportunity to invite you to an easy explanation of what happened

  3. Lena Bäcker March 22, 2011 at 2:18 pm

    Interesting point of view.

  4. […] PROFESSION CONCEDES TO WILLIAM WHITE By Greg Ransom, on March 22nd, 2011 Joseph Stiglitz: The most remarkable aspect of the recent conference at the IMF was the broad consensus that the […]

  5. Angus Cunningham March 22, 2011 at 9:55 pm

    Mr. Stiglitz wrote: “This crisis, like so many earlier crises, was a credit crisis; but few of the macroeconomic models modeled credit; neither banks (perhaps particularly surprising in models used by central banks) nor securitization was typically incorporated into the analysis. While in normal times, credit and money may be highly correlated, this is not so in the usual times surrounding crises, which is when we need to turn to models for guidance.”

    When the crisis finally erupted in late 2008, credit conditions had been “departing from normal” for several years. Derivatives outstanding had grown 2000% of what they were a decade before, when Long Term Capital Management went belly up — an event in which securitized derivatives was also a factor. So the question everyone outside the professions of finance, economics, and politics is asking is: “What the hell are you guys doing talking about macroeconomic models when the cause of the crisis is staring you in the face and very little has been done to avert that same cause — unconscionable behaviour in derivatives design, rating, insurance, promotion, and trading — from biting us again, and soon, judging by the bubbles now burbling away in energy, food, and rare metals?”

    So, Mr. Stiglitz, would you do me the favour of reading a paper that has been written by people from both within the professions in which you are famous and by others who are not blind-sided gazing at our macro-economic navels? It’s at this URL: http://www.authentixcoaches.com/ACdsFCF-1.html

  6. […] wrote a blog (March 22, 2011) – A Balanced Debate About Reforming Macroeconomics – which attempts to sum up the conclusions of the […]

  7. […] of Kuhnian “normal science” is over in macroeconomics, banking, and finance — the news comes directly from the top guns in science. What killed it? A series of empirical and conceptual anomalies — Hayekian facts — too […]

  8. J. Murray March 23, 2011 at 2:01 pm

    Self regulation? Since when? Financial regulation is only less onerous than medical regulation, and the medical field is arguably even worse off.

    I think one of the major problems in economics is the odd assumption we even operate in a free market.

  9. Frans C Verhagen March 23, 2011 at 3:19 pm

    Two monetary routes for these carbon-constrained times

    “Macro and Growth Policies in the Wake of the Crisis” was a significant IMF conference on March 7 and 8 where frank discussions prevailed about past economic theories and about new paths to be hewed by economists.
    David Romer has pointed out in his blog post about the gap of not dealing with unemployment in this important conference. I think there is a second gap, the treatment of which would have framed the conference more realistically. It is the gap of micro/macro economics and the climate change challenge.
    Though dealing with this challenge can be done in different economic branches two routes, still mainly unexplored, can be envisaged for monetary economists.
    It is the reformist route of developing green bonds that would function as an important reserve asset, somewhat similar to Global Green Backs proposed by Stiglitz (not at the conference) and the transformational route that would introduce a carbon monetary standard. While the former route is being discussed by some monetary economists, the latter route is not.
    Basing the international monetary system on a carbon standard not only transforms that system, but also the financial, economic and commercial systems which are bound together by the glue of the monetary system.
    One of the main advantages of exploring this transformational route is the potential of a carbon-based international monetary system to function as the linchpin of a global governance system that integrates the social, economic and environmental challenges in these carbon-constrained times. Such system could make a veritable contribution to the Rio 2012 Earth Summit where nations will come together to consider the potential of a Green economy as part of an integrated approach to sustainable development. As part of the preparation for this axial conference I prepared a “think-piece” about the transformational route that is available on http://www.earthsummit2012.org/index.php/news/368-sdg-thinkpieces

  10. […] I grabbed the very relevant quote above from a post yesterday, March 22, 2011, at IFMDirect by Joseph Stiglitz entitled A Balanced Debate About Reforming Macroeconomics. […]

  11. Matthew Swaringen March 27, 2011 at 12:37 pm

    Rodger, I couldn’t disagree more. You must know absolutely nothing about the history of nations that have attempted the “printing money” solution to problems. Of course you’ll say that we should control it better than Zimbabwe or Weimar but do you really think they planned on it getting out of hand? Of course not.

    Your ideas are extremely dangerous when implemented. Printing money is horribly devastating to those who get the new money last, who will have their wealth stolen from them. And how dare people save money and earn a return on it, with your inflationary system these people would get no benefit from lengthened time preference.

    Governments that create inflationary environments create a culture where people do not save, do not invest, are relatively unproductive, who spend money quickly in order to get the goods they want while caring nothing for the future.

    It’s human already to value present goods over future goods, so this distortion only further prevents investment and drives overconsumption.

    Something else interesting on top of what you wrote above is that these AAA and A ratings were handed out by a ratings cartel that existed due to regulations (the NRSRO designation granted by the SEC).

    There is not one part of this crisis that did not have regulation all over it.

  12. Rodger Malcolm Mitchell March 27, 2011 at 3:50 pm

    Matthew, please educate me about Zimbabwe and Weimar, since you claim to know about them. Exactly what caused each nation’s hyperinflation? (It was different for each) and how does that relate to the U.S. situation.

    I really become impatient with every debt hawk continually tossing in Zimbabwe and Weimar, as though merely by saying these names, they now have made some profound point, when in fact they don’t have a clue.

    Fact: ln the past 40 years, our federal debt has grown an astounding 3,600%. So where is the inflation, much less the hyperinflation (which by the way, the U.S. never has had, even through two world wars and numerous smaller wars)?

    And as for the S&P ratings of Monetarily Sovereign nations, they aren’t worth crap. S&P will be long gone, and America still will be paying its bills on time, in full.

    Get some facts.

    Rodger Malcolm Mitchell

  13. Paul Friesen May 10, 2011 at 9:09 pm

    Models of the sort I was presented with in graduate courses do not seem at all suited to understanding the financial crisis. But the old IS-LM model I was taught in undergraduate classes seems to capture it very well if you just add a lower bound on the interest rate.

    If you shift the IS curve enough to the left, the curves will cross below zero. Output will be on the IS curve at the zero line. That is where the U.S. is now. There is no mystery about why the recession is so long-lasting, or why monetary policy is so impotent. Fiscal policy could shift the IS curve to the right sufficiently for the curves to cross above zero as usual, but sufficient stimulus has not been applied and the politics of the situation make that unlikely to change for the foreseeable future. This looks like a very long recession to me.

  14. Per Kurowski May 12, 2011 at 8:05 am

    @Paul Friesen “This looks like a very long recession to me”

    Indeed, before we get rid of the nonsensical and arbitrary regulatory discrimination against small businesses and entrepreneurs that are hardwired into current bank regulations, it could in fact be a never-ending recession.

    USA, whatever happened with that of “the land of the brave”? Have you forgotten that risk-taking is an essential element for any country that wishes for a better future?

  15. Jacobs November 8, 2011 at 8:46 pm

    Hyperinflation in Zimbabwe:

    No. They really DIDN’T try to control their hyperinflation. It wasn’t a priority for them. We could hyperinflate our currency right now. We don’t because monetary stability IS a priority.

    As for inflation eating the hard earned savings of the poor (as if THAT’s a risk.), when inflation increases, interest rates stay ahead. Virtually without exception. People spend their money rather than let it erode. The only reason people don’t spend in inflationary environments is they can lend it to those in need at rates higher than inflation. Debt hawk arguments self-contradict!

    Government spending increase inflation and erodes people’s wealth!

    Government spending will cause interest rates to rise! People who have money to lend will earn more!

    Wait… what?
    MMT acknowledges the constraints of inflation. Printing money in the absence of inflation does not cause hyperinflation. If it did, by some odd chance, the fed could increase interest rates just as Volker did to tame the Nixon-Carter, early Reagan years inflation rates.

    This chokes off money supply and stabilizes the currency’s value. Hyperinflation is crushed.

Leave A Comment