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Reconstructing Macroeconomic Theory to Manage Economic Policy

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Fruitful Economics

Abstract

It is a great pleasure for me to participate in this event celebrating Jean-Paul Fitoussi’s contribution to economics and to public life. There are so many aspects of his work and of his collaborations over a long period of years on which I feel I should comment: His role, for instance, in the International Commission on the Measurement of Economic Performance and Social Progress, has provided a critical impetus to what is now a major global movement. The commission’s work was not just about measurement; it was about shaping our society, for what we measure affects what we do.1 I should talk too about his contributions over a quarter century to the International Economic Association, where he served as Secretary General, and which he continues to advise. I could talk as well about his efforts to reshape the G20 agenda when France chaired that group,2 or the work we did together in the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, in the aftermath of the global financial crisis.3

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Notes

  1. This essay owes an enormous intellectual debt to Jean-Paul Fitoussi. I should also acknowledge helpful discussions with Rob Johnson and my long-term collaborator, Bruce Greenwald. Financial support from INET is gratefully acknowledged. Research and editorial assistance were provided by Eamon Kircher-Allen and Sandesh Dhungana. University Professor, Columbia University. J. Fitoussi, A. Sen, and J. E. Stiglitz: Mismeasuring Our Lives: Why GDP Doesn’t Add Up, New York: The New Press, 2010.

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  2. The G20 and Recovery and Beyond: An Agenda for Global Governance for the Twenty-First Century, J.P. Fitoussi and J. E. Stiglitz (eds), e-book with contributions from The Paris Group, 2011.

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  3. Quoted in Stewart Lansley: The Cost of Inequality, London: Gibson Square, 2012, p. 224.

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  4. J. P. Cotis: “Editorial: achieving further rebalancing”, OECD Economic Outlook, 1: pp. 7–10 (at p. 7), 2007.

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  5. See Jean-Paul Fitoussi: 2013, Le théorème du lampadaire, Paris: Les liens qui Libèrent.

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  6. B. Greeenwald and J. E. Stiglitz: “Keynesian, New Keynesian, and New Classical Economics,” Oxford Economic Papers, 39: pp. 119–133, March 1987.

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  7. See J. E. Stiglitz: “Information and Capital Markets,” in William F. Sharpe and Cathryn Cootner (eds), Financial Economics: Essays in Honor of Paul Cootner, Prentice Hall, New Jersey, 1982, pp. 118–158; and the introduction to its reprinting in Selected Works of Joseph E. Stiglitz,Volume II, Oxford: Oxford University Press, 2013, pp. 55–84.

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  8. Bruce Greenwald and J. E. Stiglitz: “Externalities in Economies with Imperfect Information and Incomplete Markets,” Quarterly Journal of Economics, 101(2): pp. 229–264, May 1986.

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  9. There is a growing literature focusing on exploring the macroeconomic implications of the externalities that Greenwald and I identified, e.g., not just for self-selection and incentive compatibility constraints, but also for borrowing constraints. See, for example, Jeanne, Olivier and Anton Korinek: “Excessive Volatility in Capital Flows: A Pigouvian Taxation Approach,” American Economic Review, 100(2): pp. 403–407, 2010; and “Managing Credit Booms and Busts: A Pigouvian Taxation Approach,” NBER Working Paper Number 16377, 2012, available at http://www.nber.org/papers/w16377.pdf (accessed June 10, 2013).

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  10. See, for example, J. E. Stiglitz: “Alternative Theories of Wage Determination and Unemployment in L.D.C.’s: The Labor Turnover Model,” Quarterly Journal of Economics, 88(2): pp. 194–227, May 1974; and

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  11. Carl Shapiro and J. E. Stiglitz: “Equilibrium Unemployment as a Worker Discipline Device,” American Economic Review, 74(3): pp. 433–444, June 1984.

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  12. They also provided, I believe, a better explanation of nominal rigidities than the fashionable menu cost theory. See B. Greenwald and J. E. Stiglitz: “Toward a Theory of Rigidities,” American Economic Review, 79(2): pp. 364–369, May 1989.

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  13. I. Fisher: “The Debt Deflation Theory of Great Depressions,” Econometrica, 1(4): pp. 337–357, 1933.

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  14. Even if wages and prices fall, it does not mean that real wages change. That depends on differences in the rates of changes in wages and prices. There can be real wage rigidities even in the presence of flexibility of nominal wages and prices. See R. Solow and J. E. Stiglitz: “Output, Employment and Wages in the Short Run,” Quarterly Journal of Economics, 82: pp. 537–560, November 1968.

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  15. See Charles Kindleberger: Manias, Panics, and Crashes: A History of Financial Crises, New York: Basic Books, 1978.

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  16. Greenwald and Stiglitz show how price flexibility can lead to large balance sheet effects, leading firms curtail production, employment, and investment, amplifying the effect of any shock. (This is sometimes referred to as the financial accelerator.) (Because it takes time for balance sheets to be restored, the effects of the shock are likely to be persistent.) The effects can be further amplified as a result of impacts on bank balance sheets, leading them to contract lending. See B. Greenwald and J. E. Stiglitz: “Financial Market Imperfections and Business Cycles,” Quarterly Journal of Economics, 108(1): pp. 77–114, February 1993; and

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  17. B. Greenwald and J. E. Stiglitz: Towards a New Paradigm in Monetary Economics, Cambridge: Cambridge University Press, 2003.

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  18. J. Stiglitz and Martin M. Guzman: “Pseudo-wealth and Consumption Fluctuations,” Columbia University Working Paper, presented at the World Congress of the IEA, June, 2014.

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  19. J. Scheinkman and W. Xiong: “Overconfidence, Short-Sale Constraints and Bubbles,” Princeton Economic Theory Working Papers 98734966f1c1a57373801367f, 2003.

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  20. See Jean-Paul Fitoussi: “Wage Distribution and Unemployment,” American Economic Review, Papers and Proceedings, 84(2): pp. 59–64, May 1994; and

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  21. Jean-Paul Fitoussi and Francesco Saraceno: “Inequality, the Crisis and After,” Rivista di Politica Economica, Série III, fascicule I-III: pp. 9–27, January–March 2011.

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  22. See, for example, K. E. Dynan, J. Skinner, and S. P. Zeldes: “Do the Rich Save More?” Journal of Political Economy, 112(2): pp. 397–444, 2004.

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  23. See K. Dynan: “Is a Household Debt Overhang Holding Back Consumption?” Brookings Papers on Economic Activity, pp. 299–362, Spring 2012, available at http://www.brookings.edu/~/media/Projects/BPEA/Spring%202012/2012a_Dynan.pdf (accessed June 10, 2013); and

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  24. A. Mian, K. Rao, and A. Sufi: “Household Balance Sheets, Consumption, and the Economic Slump,” June 2013 working paper, available at http://papers.ssrn.com/sol3/papers. cfm?abstract_id=1961211 (accessed June 12, 2013).

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  25. See discussion in Dynan, Skinner, and Zeldes, op. cit.; Stephen P., Zeldes discusses such constraints in more detail in “Consumption and Liquidity Constraints: An Empirical Investigation,” Journal of Political Economy, 97(2): pp. 305–346. 1989.

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  26. Robert Lucas: “The Industrial Revolution: past and present”, 2003 Annual Report Essay, The Federal Reserve Bank of Minneapolis, May 1. Accessed from http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3333 (accessed June 18, 2014).

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  27. For an excellent discussion of these issues, see Dean Baker: “The Myth of Expansionary Fiscal Austerity,” CEPR, Washington, DC; IMF, 2010, Economic Outlook, chapter 3; and

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  28. Arjun Jayadev and M. Konczal: “The Boom not the Slump: The Right Time for Austerity,” The Roosevelt Institute, August 23, 2010.

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  29. Alberto Alesina and Silvia Ardagna: “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, pp. 35–68, 2010.

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  30. See, for example, International Monetary Fund: “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation,” in World Economic Outlook: Recovery, Risk, and Rebalancing, Washington, D.C.: IMF, pp. 93–124, 2010.

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  31. For a discussion of some of the issues raised here, see Robert M. Solow: “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, MA, The MIT Press, 2012, pp. 73–76.

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  32. Recent econometric studies do show significant multipliers, for example, around 1.5. See Emi Nakamura and Jon Steinsson: “Fiscal Stimulus in a Monetary Union: Evidence from US Regions,” American Economic Review, American Economic Association, 104(3): pp. 753–792, March, 2014.

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  33. Alexander, Field: A Great Leap Forward: 1930s Depression and U.S. Economic Growth, New Haven: Yale University Press, 2011.

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  34. P. Neary and J. E. Stiglitz: “Toward a Reconstruction of Keynesian Economics: Expectations and Constrained Equilibria,” Quarterly Journal of Economics, 98, Supplement: pp. 199–228, 1983.

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  35. J. E. Stiglitz, Freefall, op. cit. and Linda Bilmes and J. E. Stiglitz: The Three Trillion Dollar War: The True Costs of the Iraq Conflict, WW Norton, 2008.

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  36. Thomas Herndon, Michael Ash, and Robert Pollin: “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Cambridge Journal of Economics 38(2): pp. 257–279, 2014.

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  37. Anton Korinek and J. E. Stiglitz: “Dividend Taxation and Intertemporal Tax Arbitrage,” Journal of Public Economics, 93(2009): pp. 142–159.

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  38. Some (Woodford, 2003, 2009) have suggested that what is required is a credible commitment to inflation (e.g., through price-level targeting, which implies when there is less than normal inflation now, perhaps due to deflationary pressures arising from excess capacity, there will be higher than normal inflation in the future). But even if the expected real interest rate were the critical determinant of investment (which we suggest it is not), there is no way that the monetary authority could commit itself to such a policy. See M. Woodford, “Optimal interest-rate smoothing”, The Review of Economic Studies, 2003, 70(4): 861–886. and

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  39. M. Woodford, Convergence in Macroeconomics: Elements of the New Synthesis. American Economic Journal: Macroeconomics, 2009, 1(1): 267–279.

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  40. See, in particular, Jean-Paul Fitoussi: “Following the Collapse of Communism, Is There Still a Middle Way?” in Colin Crouch and Wolfang Streeck (eds), Political Economy of Modern Capitalism, London: Sage Publications, October 1997, pp. 148–160.

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  41. J. P. Fitoussi and E. S. Phelps: The Slump in Europe, Reconstructing Open Economy Theory, Basil Blackwell, 1988.

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  42. J. Hicks: “Mr Keynes and the Classics: a suggested interpretation,” Econometrica, vol 5, 2: 147–159, April 1937.

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  43. Modigliani, for instance, seems to support such an interpretation: The ability of the model set out in the General Theory to explain the persistence of unemployment could be traced primarily to the assumption of wage rigidity. Franco Modigliani: “The Monetary Mechanism and its Interaction with Real Phenomena,” in A. Abel (ed.): The Collected Essays of Franco Modigliani, Vol. 1, Essay in Macroeconomics, MIT Press, 1944.

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  44. J. P. Fitoussi: (ed.) Modern Macroeconomic Theory, London, Basil Blackwell, 1982.

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  45. B. Greenwald and J. E. Stiglitz: “Keynesian, New Keynesian, and New Classical Economics,” Oxford Economic Papers, 39: 119–133, March 1987.

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  46. J. P. Fitoussi: Le débat interdit, Arlea, 1995

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  47. The recent, important book of Thomas Piketty not only generalizes this proposition, but contains an empirical research that convincingly demonstrates to what kind of capitalism the persistence of such a gap will lead. See Thomas Piketty Capital in the XXIrst Century, Cambridge, MA.: Harvard University Press, 2014.

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  48. J. P. Fitoussi and F. Saraceno: “Fiscal discipline as a social norm: the European stability pact,” Journal of Public Economic Theory, 10(6): 1143–1168, December 2008.

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  49. J. P. Fitoussi and F. Saraceno:“European economic governance: the Berlin-Washington Consensus,” Cambridge Journal of Economics, 37(3): 479–496, 2013.

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Authors
  1. Joseph E. Stiglitz
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Editor information

Editors and Affiliations

  1. OFCE, Sciences Po, Paris, France

    Éloi Laurent (Senior Economist) (Senior Economist)

  2. University of Pau-Pays de l’Adour, France

    Jacques Le Cacheux (Professor) (Professor)

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© 2015 Joseph E. Stiglitz

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Stiglitz, J.E. (2015). Reconstructing Macroeconomic Theory to Manage Economic Policy. In: Laurent, É., Le Cacheux, J. (eds) Fruitful Economics. Palgrave Macmillan, London. https://doi.org/10.1057/9781137451057_3

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