Working Paper: NBER ID: w21444
Authors: Joseph E. Stiglitz
Abstract: This paper, an extension of the Presidential Address to the International Economic Association, evaluates alternative strands of macro-economics in terms of the three basic questions posed by deep downturns: What is the source of large perturbations? How can we explain the magnitude of volatility? How do we explain persistence? The paper argues that while real business cycles and New Keynesian theories with nominal rigidities may help explain certain historical episodes, alternative strands of New Keynesian economics focusing on financial market imperfections, credit, and real rigidities provides a more convincing interpretation of deep downturns, such as the Great Depression and the Great Recession, giving a more plausible explanation of the origins of downturns, their depth and duration. Since excessive credit expansions have preceded many deep downturns, particularly important is an understanding of finance, the credit creation process and banking, which in a modern economy are markedly different from the way envisioned in more traditional models.
Keywords: Deep downturns; Financial market imperfections; Macroeconomic theory; Credit creation; Economic volatility
JEL Codes: D59; D90; E20; E21; E30; E32; E44; E49; E50; E52; E60; F41; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shocks to firm equity (G12) | reductions in demand and supply (J23) |
| reductions in demand and supply (J23) | magnitude of volatility during downturns (E32) |
| endogenous market dynamics (D52) | credit bubbles (E51) |
| credit bubbles (E51) | economic downturns (F44) |
| financial market imperfections (G19) | economic fluctuations (E32) |
| structural issues in the economy (L16) | persistence of downturns (E32) |
| rigidities in labor and credit markets (J48) | slow recovery of balance sheets (F65) |
| slow recovery of balance sheets (F65) | persistence of downturns (E32) |