Bubbles, stability, Stiglitz

As soon as you guys have read the title and saw the article I’m discussing, you are probably expected me to go off about Stiglitz – given that, although he’s a genius, his views tend to be a touch unorthodox and I’m a slave to orthodox economic theory.  But this isn’t the case.  There are a couple of things I disagree with in the article, but I actually felt what he wrote was pretty good – in fact most of it is more orthodox than many may realise.

Now, I disagree with his assertion that:

They failed to predict the crisis; standard models even said bubbles couldn’t exist — markets were efficient.

Of course, the EMH suggests that we can’t predict crisis – and doesn’t say their can’t be bubbles.  Hell, the macro text book I’ve got next to me has a great deal on where bubbles pop up in models.  Personally, I’d go as far as saying that the “popping bubble” was not the main issue at stake during the GFC – it was the break down in trust and reputational capital in the finance sector combined with a slow policy response.  But I digress.

He also states:

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.

This is a little loose.  The objective the central bank is to run a fiat money system without incurring undue variability in the real economy – we want the certainty and efficiency associated with fiat money and price stability, but we want to avoid ADDING to variability in real output.  My only real disagreement here is that I still believe ensuring price stability is the best way to achieve any cyclical goals from monetary policy – when he does not believe this.

But ignore this, he has some great insight, namely:

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.

The discipline needs to build and develop – and recognising that helps us understand that the discipline isn’t in some magical “final state” where it can provide all knowledge.  This isn’t a critique of the discipline – it is an admission that the discipline needs to keep learning and growing.  Furthemore, it shows he still believes in reductionism – which I’m glad to hear.

Nice.