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  • The editor in charge of this paper was Fabrizio Zilibotti.

  • Acknowledgments: Adam Smith Lecture presented at the European Economic Association annual Congress, Glasgow, 24 August 2010. The author is University Professor, Columbia University, Chair of the Management Board and Director of Graduate Summer Programs, Brooks World Poverty Institute, University of Manchester, Senior Fellow and Chief Economist, Roosevelt Institute, and a member of the Advisory Board, Institute for New Economic Thinking. I wish to thank Rob Johnson, Anton Korinek, Jonathan Dingel, Mauro Gallegati, Stefano Battiston, Domenico Delli Gatti, Arjun Jayadev Eamon Kircher-Allen, Sebastian Rondeau and Bruce Greenwald for helpful discussions and comments. Many of the ideas are based on joint work with Greenwald (Greenwald and Stiglitz 1993, 2003a).



The standard macroeconomic models have failed, by all the most important tests of scientific theory. They did not predict that the financial crisis would happen; and when it did, they understated its effects. Monetary authorities allowed bubbles to grow and focused on keeping inflation low, partly because the standard models suggested that low inflation was necessary and almost sufficient for efficiency and growth. After the crisis broke, policymakers relying on the models floundered. Notwithstanding the diversity of macroeconomics, the sum of these failures points to the need for a fundamental re-examination of the models—and a reassertion of the lessons of modern general equilibrium theory that were seemingly forgotten in the years leading up to the crisis. This paper first describes the failures of the standard models in broad terms, and then develops the economics of deep downturns, and shows that such downturns are endogenous. Further, the paper argues that there have been systemic changes to the structure of the economy that made the economy more vulnerable to crisis, contrary to what the standard models argued. Finally, the paper contrasts the policy implications of our framework with those of the standard models.